Microsoft: 32% Upside Once Windows 8 Jitters Subside

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

Microsoft (NASDAQ: MSFT) shareholders have had a rough few months lately, watching shares fall from a high of $31.61 in late September to the current price of $26.46 as of this writing.  The market has reacted pessimistically to the Windows 8 launch, as well as other developments such as the high-end pricing of the company’s tablets.  With the company trading only 4.6% above its 52-week low, should investors be worried, or is this a tremendous buying opportunity?

One of the biggest reasons for the negative outlook on Windows 8 is the departure of Windows division president Steven Sinofsky.  Some believe that his resignation means that executives are disappointed in how Windows 8 turned out; however, he could have resigned for a variety of reasons, and there hasn’t been nearly enough feedback from the market yet to call Windows 8 a success or failure.

Another reason that the market is pessimistic is the high-end pricing of Microsoft’s line of tablets, the Surface.  The current Surface starts at $499, which runs Windows RT and works exclusively with apps available in the Windows store.  These do not have much of a chance to compete with the lower-priced tablet market. This includes the Google (NASDAQ: GOOG) Nexus 7, which starts at $199 and has much of the same capabilities as the Microsoft product.  Even the highest priced Google tablet costs only $299, and this gets you 32GB of storage, plus AT&T data capabilities, which is not even available on the Surface.  The only real functionality advantage that I notice is the 10.6” display on Microsoft’s product, compared to a 7” display on the low-cost Google device.  Even the 10” version of the Nexus starts at $399, a full $100 lower than Microsoft’s unit.

As if the RT Surface wasn’t priced high enough, the upcoming Windows 8 version of the Surface starts at $899, which strikes me as being entirely too high.  Even Apple’s (NASDAQ: AAPL) latest version of the iPad starts at just $499, and I think it is safe to say that Apple has the most loyal customers of any manufacture, so they are unlikely to be lured away by a Microsoft product that costs $400 more and won’t run their favorite apps.  Even the most expensive fully-loaded iPad is $829, $70 less than Microsoft’s base version.

However, I am still optimistic about Windows 8, particularly its touch capabilities (one of Microsoft’s huge selling points).  As the personal computing market shifts more and more to tablet PC’s, Windows 8 tablets are expected to grow their market share considerably between now and 2016.  According to market research firm IDC, Windows tablets are expected to comprise only 2.9% of the worldwide tablet market by the end of this year.  They expect this to rise to a 10.3% market share; however, that would be even better than it sounds. 

Worldwide shipments of tablets are expected to be 122.3 million units currently, which means about 3.5 million of them are Windows 8 tablets based on the 2.9% figure mentioned above.   By 2016, shipments are expected to reach 282.7 million units, and if Microsoft achieves the 10.3% market share that IDC predicts, their share of that is 29.1 million tablets running Windows 8.  That is a 730% gain in the number of tablets using Microsoft’s OS within 4 years! 

Despite all of the concerns, analysts are overwhelmingly bullish on the company, with an average 1-year price target of $34.94 amongst the analysts covering the company.  This represents a 32% upside over current levels and there could be more to come if the projected tablet growth proves accurate.  Microsoft currently trades at only 8.8 times projected 2013 earnings of $3.02 per share, an enormous discount to historical levels.  If Windows 8 proves to be a success, Microsoft should trade around their historical P/E multiple of 11, which would put the stock around $37.  And by the way, in the meantime the company is paying a 3.48% dividend yield while you wait.

KWMatt82 owns shares of Apple. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Google, and Microsoft. 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!

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