Buy This Giant on Positive News

Mohsin 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) is trading at very cheap valuations, far below the industry averages. The industry is seriously discounting the stock based on the uncertainty surrounding Windows 8's success. I believe that the market is already pricing the stock for the worst, and any positive news from these earnings would push the stock high.

The company has already claimed that it has sold more than 60 million Windows 8 units, and this will be reflected in this quarter’s earnings. I recommend investors take advantage of these cheap valuations and buy Microsoft on WP8 traction, Xbox & Surface success, and expected good performance of Windows 8.

The Giant

Microsoft  is the world’s leading provider of software products and services. Its Windows and Office products have dominated their respective markets for the last two decades. The company also provides enterprise services with its Servers and Tools division. This division provides the Windows server operating system, Windows Azure, SQL, Intune, Visual Studio, and Silverlight, among others.

Maturing business

The company has been facing slowing growth in its primary Windows and Office products. This is mostly due to the fast maturing PC industry which showed negative growth for the first time in over 12 years.

The shareholders can’t blame Microsoft for not anticipating this slowdown of growth because the company has been spending billions of dollars on the next big thing through acquisitions and R&D. Sadly for investors, other than Xbox, it has only resulted in string of failures such as Bing, Zune, and the smartphone OS, costing investors billions.

The turnaround bid

The company renewed its focus on its smartphone operating system development after Google’s Android success made it apparent that handhelds were the future of the tech industry. It all kick started with the announcement of a partnership with Nokia (NYSE: NOK) to launch the next revolutionary operating system for smartphones and a new touch-based Windows OS.

The WP7-boarded Lumia was able to make ripples but not the splash Microsoft and Nokia expected. Therefore, it was soon replaced by an updated version, named Windows Phone 8.  This launch was to coincide with the launch of Windows 8, Microsoft’s first touch based operating system.

However, Microsoft is not the only company looking to bring its Phone OS back from the brink of extinction. Research in Motion (NASDAQ: BBRY) is also looking to save its struggling OS. The company has launched its final turnaround bet BlackBerry 10 (BB10); it will be available by the end of this month. In the last few months, the positive sentiment about the new OS has almost doubled the stock price of RIMM. However, I believe WP8 has a much better chance of comeback because unlike BB10, it is available on a number of different devices, such as Samsung, Nokia, HTC etc. 

It is now or never

This quarter holds great importance for Microsoft because it will decide the success of its Windows 8 and WP8. If the world’s largest operating system manufacturer is not able to generate enough sales, it won’t bode well for the future growth prospects of Microsoft’s stock.

The company has also taken a big risk by launching its first foray into PC hardware with the Surface Tablet. The ‘risk’ is the displeasure of Windows eco system partners (OEMs) which rely on Microsoft to provide OS for their hardware and feel betrayed by Microsoft for manufacturing its own hardware.

If the Surface does not gain traction, it would be a big blow to the company. It would give OEMs such as HP, Lenovo, Dell, and Asus a reason to adopt Android on their tablets and ultra-books. This is because the Surface is far ahead of any competition in terms of design and hardware, therefore the failure would be the failure of Windows 8 and not only of the Surface products.

Bottom line

According to recently released IDC data, PC shipments fell by 6.4% in the 4th quarter of 2012. This would mean that only 89.8 million PC shipments actually took place. The firm was expecting the decline to be around 4.4%.

On the other hand, Microsoft is claiming that it has already sold more than 60 million units of Windows 8. It will be clarified in the 4th quarter earnings, which Microsoft is scheduled to announce on the 24th of January.

This event would be a major catalyst for the stock and I believe the market is already pricing the stock for the worst. Any positive news from the earnings would significantly affect the stock price.

Valuations

The stock is currently trading at a forward P/E of 8.4x which is approximately 60% below sector average.  The mean sell side price target for Microsoft is currently $34, a 30% return at these levels. The software giant also offers an excellent dividend yield of 3.4%, which is 64% above industry average.

Conclusion

At these levels the market is placing a very high discount on Microsoft, primarily based on the uncertainty surrounding Windows 8's success. I believe the recent Nokia preannouncement is an early indicator of WP8 success which can give Microsoft a strong footstep in the handheld OS market and Google a serious run for its money.

Microsoft has also become the North American leader, in gaming consoles with its Xbox products. Even an average response to Windows 8, when combined with continued growth of Xbox, good performance of WP8 and Surface effect, can seriously push the stock to mean sell side estimates. Therefore, I believe this an excellent opportunity to buy Microsoft.


SmartEquity has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of 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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