Why Microsoft Deserves a Spot in Your Portfolio Now

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Whether you think the market is still headed sky-high, or you fall more in line with the gloomy Marc Faber crowd, looking for good deals is always a great idea. As the market shoots up, there are usually less deals available. One good deal still left is Microsoft  (NASDAQ: MSFT).

Valuations:

Microsoft isn't exactly cheap at 15 times earnings -- but it is fairly valued. Looking at its forward P/E of a little under 9, however, the company looks pretty cheap. After posting a record quarter with revenues reaching $21.5 billion, the company is sitting on over $68 billion in cash with little debt. With one of the strongest balance sheets in the entire market, Microsoft also pays out an awesome dividend that yields 3.30%. This is one of the safest dividends you will find, and the company trades sideways in a tight range between the mid twenties to low thirties -- making the stock almost bond-like. Many argue that the company always has and always will be stuck in this range, but they rarely ever mention that the company has been steadily reducing the number of shares outstanding, or the fact that their P/E ratio has been significantly compressed as the company has continued to increase its earnings over the last ten years.

Why hasn't the share price moved?

Why didn't Wal-Mart’s share price move for what seemed like forever before breaking out? Mr. Market doesn't always catch on so quickly, but catalysts are capable of waking him up. Could Microsoft eventually break out of its boring, capital-appreciationless range? With the right catalysts, it definitely could. What are the potential catalysts?

1.) Xbox 720-- the next generation Xbox may be debuted as soon as April.

2.) Increasing earnings per share and increased buybacks.

3.) Increasing dividend- even with a yield of 3.30%, the company has a low payout ratio of 45%.

4.) Windows 8 catching on even a little, as the pessimism surrounding it is ridiculously negative and likely already baked into the price.

And then there's the cloud

Microsoft isn't touted as a cloud player much, but it should be. Microsoft's cloud platform, Azure, was recently downed by an expired SSL (secure sockets layer) certificate, which is embarrassing to say the least, but the company finally got it up and running again Saturday. This gets all the attention, but don't let it cloud your judgment on Azure. Azure was named the world’s best public cloud storage service days before it ironically crashed and burned. 

Nasuni rigorously tests cloud service providers (CSP), and benchmarks them annually. Last year the title for best performer went to Amazon  (NASDAQ: AMZN). This year? Microsoft's Azure took that title away. Nasuni tested Azure, Amazon Web Services (AWS), Hewlett Packard, Rackspace and Google Cloud-- in other words, the five largest CSPs. Although Amazon still wears the crown for fastest write speeds for files larger than 1MB, Microsoft has them beat on files less than 1MB, on both write and read speeds. Although Amazon showed no meaningful errors under a stress test, Nasuni clarified that: "Not only did Microsoft outperform the competition significantly during the raw performance tests, it was the only cloud storage platform to post zero errors during 100 million reads and writes. In those categories where Microsoft was not the top performer (uptime and scalability variance), it was a close second."

A new king of the cloud?

Not only is Microsoft improving its cloud services; it is emerging as a performance leader. The recent outage, however, was a huge misstep. Amazon isn’t going away any time soon, either, and still has big name customers. Adrain Cockcroft, the cloud architect that helped move Netflix (NASDAQ: NFLX) to Amazon's cloud stated that:

“Streaming of movies is the future and rather than hang on to our leadership in existing models and see someone else topple the Apple cart, Netflix had to take the bold step to disrupt itself and gain leadership in the new model before others," reasoning that, “Amazon has hundreds, if not thousands of people working on optimizing, automating the infrastructure. Netflix could not imagine scaling to that level.”

Microsoft is now more than capable of "scaling to that level" as well. Netflix was a big win for Amazon, but Microsoft has also scored big name customers, with Amazon rival Ebay deciding to go with Microsoft Azure. More customers will likely come, especially with Microsoft being most recently named best performer in cloud services. Let's not forget that the now #2 Amazon has also had its share of problems with cloud outages. I'm sure that even Netflix (as well as Instagram, and Pinterest) can attest to Amazon's previous cloud outage blunders. Netflix is also continuing to build off of AWS, open sourcing its cloud-management tools for other developers to build off of. 

The bottom line

Microsoft makes for a safe investment in today's environment. With a rock-solid balance sheet, a high yield, and little debt, the company is financially strong and pays investors nicely. If you want instant capital appreciation, pass this one up. If you are patient, and satisfied with a great and safe dividend, then Microsoft is for you -- especially considering that the company is priced at only around 9 times forward earnings. The savvy investor can quickly conclude that if the company meets its annual EPS estimate of $2.85 predicted by analysts, and is priced around today's valuation of 15 times earnings, then the share price should be about $42 to $43 -- a nice little gain from its current share price.

The company is also diversified in its offerings, and besides its emerging leadership in the cloud computing revolution, other catalysts exist such as the Xbox 720. Windows 8 failing is pretty much baked into the price at this point, so if the OS catches on, which I think it will, then the market may finally give the company some respect. When the worst-case scenario of owning a stock is that it stays range-bound, paying you an increasing dividend of over 3%, with the potential for a pop in share price -- you can't really complain. The potential for upside is there and the downside is extremely limited, making Microsoft a safe bet for 2013.


Jharry1 owns shares of Microsoft. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com, Microsoft, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure