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Is This Tech Giant's Strategy Killing Its Stock?

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

Microsoft’s (NASDAQ: MSFT) largest revenue sources are its Windows operating programs and the Office productivity software.  These were great revenue sources up until the early 2000s.  Since then, PC sales have taken an absolute dive and the industry appears to be on the brink as consumers turn to tablets and other “new” technologies.  Take a look at Hewlett-Packard (NYSE: HPQ) just to see how bad the PC market really is right now, and Intel (NASDAQ: INTC), which has increasingly complained about the slumping semiconductor demand due to poor PC sales. Gimme Credit recent cut its rating on Hewlett-Packard to "deteriorating" from "stable". According to analyst Dave Novosel, "Revenue declines are accelerating, with weakness across all segments except software". Meanwhile, Intel has been trading near its 52-week low. Why? Investors are not confident in Intel. If they don't see advances on the mobile side of its businesses, then they see it as a dying business.  Intel needs to focus more deeply on the mobile segment of its business in order to convince shareholders to deserve full value for its current earnings.

These are prime examples for why Microsoft needs to change its business strategy. If the tech giant wants to get back to its old glory days then they need to focus more on consumer devices and less on operating systems that have not done the company any favors since XP.  If Microsoft can put the primary focus on devices; such as the Surface tablet, a Windows phone, and maybe a revamped music player, I believe they will have a chance.  To this point, we know that the tablet has been a success but the phone and music player operations have had their setbacks over the years (remember the Zune?). 

The first thing Microsoft should do is a management shake up. Obviously, it has been a tough run over the past few years with this group and it is time to shake things up. Steve Ballmer, CEO of Microsoft, is a great leader and should stay at the head of the company but the company needs new executives from Google (GOOG) and Apple; companies that have already had success with the consumer devices category.  Next, the company needs to innovate and redesign its new products to give them an “edge” over its competitors.  Consumers want a device that is different and unique, that is why Apple (NASDAQ: AAPL) has had so much success.  In my opinion, the company should use the same methodology as they did coming up with the Surface tablet to make a Windows phone and a new iPod killer.  If Microsoft wants to truly be a tech threat again, this has to be the new path and mindset moving forward for the company. 

Let’s take a look at the fundamentals to see if Microsoft’s fundamental position supports my thesis above.  Microsoft has a market cap of $224 billion and currently holds a “buy” rating from analysts.  The company shows a price to earnings of 14 and a forward price to earnings of 8.21.  The company has a neutral stance on its valuation indicators with a PEG of 1.5, price to sales of 3.1, price to book of 3.3 and price to cash of 3.3.  However, the company has excellent financial health with a price to free cash flow of 10 and a quick ratio of 2.62.  Furthermore, the company has cash per share of 8 and pays a dividend of 3.5%.  Earnings growth over the next years are expected to come in at 12% increase and 10% over the next five years.  Additionally, the company has excellent margins with a gross margin of 75%, operating margin at 27.5% and a profit margin of 22%. 

As you can see, the tech giant has great fundamentals.  Additionally, I believe with the good cash flow, low debt and nice cash pile, Microsoft could enact my thesis to turn the company around.  Furthermore, over the next five years, I believe Microsoft could see EPS growth closer to its past five-year growth number of 23%.  Just think back to the beginning of Apple.  The company released the iPod but it did take a few years for the music player to get noticed. The point I am trying to make is that this turnaround will not happen overnight, or even in the next year or so. I believe that it could end up taking five years for Microsoft to fully change its mindset, engineering design and marketing strategy needed to be successful in this changing tech environment. 

The bottom line here is that Microsoft’s business model is out of date and that is why the stock has been virtually unchanged over the past several years. With a revamping of the business model and a higher focus on consumer electronics, Microsoft could soon be Apple’s biggest worry once again.  Cash wise, the company is set and can easily implement my plan to turn the company around.  The tech giant is showing a glimmer of light with the success of its Surface tablet but the days of focusing on the Windows operating system are over.  Until we see PC demand fly back to levels seen in the years prior to the Great Recession, I do not believe that Microsoft can continue to live off the operating system and Office productivity software.  Similarly, we have seen Steve Ballmer, possibly hinting to this change in a recent interview in which the CEO said that Microsoft needs to be more focused on “devices and services”. Investors should look for new Microsoft product releases over the next year or so to determine if the company is truly adapting to the new business environment. 

StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Intel, and Microsoft. Motley Fool newsletter services recommend Apple, Intel, 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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