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Leigh Baldwin & Co.

112 Albany Street, Cazenovia, NY 13035 | Phone: (315) 655-2964 Toll Free: 1-800-659-8044

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Stock of the Week

Microsoft

October 31st 2011 Microsoft
Nasdaq Symbol: MSFT
Industry: Software
Price as of 10/28: $26.98

What a difference a week makes. Thanks to a 3% rally on Thursday, the major averages had a great year in five days. Plenty of stocks are up dramatically from the October lows. MetLife our featured stock last week is up nearly 10% from last Friday's close. Overall, the earnings this season keep coming in better than expected and therefore the fears of a double dip recession are abating. The techs have become the most recommended sector by Wall Street money managers. Google, Apple, and Intel are trading at or near their 52 week highs. This week I'll feature another tech titan, Microsoft which also reported impressive earnings, but whose stock has not participated in the rally. Microsoft remains a cash cow generating over a billion dollars in free cash flow every month, but the stock remains range bound in the last year and in fact the last decade even though earnings and sales have gone up dramatically. Case in point, in the last twelve years earnings have quadrupled from 71 cents a share to an impressive $2.69 a share and yet the stock is still down 50% from its' 2000 peak level. In other words, beware of high PE stocks. Netflix shareholders are learning that painful lesson right now.

With a range bound stock, investors always look for a catalyst to cause the stock to break out. Microsoft's catalyst will hopefully be Windows 8 coming out next year. Windows 8 is a big breakthrough for Microsoft because not only will it replace PC platforms, but will also be used on smart phones and tablets with new touch screen capabilities similar to the software of Apple. Besides the improving fundamentals, Microsoft maintains a huge cash hoard of $56 billion that affords them plenty of opportunities. One money manager suggested they use the cash to buy back a quarter of the outstanding shares while also boosting their already impressive dividend which stands at a 3% yield. That would certainly snap the stock of out its range bound state. In any event, a 3% yield in this market with improving fundamentals and a fortress balance sheet that other company's dream of provides investors with good risk reward for these volatile times.

Last week, Microsoft reported in line earnings of 68 cents a share as revenue rose 7.3% to $17.37 billion verse estimates of $17.19 billion. The Microsoft Business Division reported $5.62 billion in first quarter revenue, an 8% increase from the prior year period which included the launch of Office 2010. The Server & Tools segment posted $4.25 billion in first quarter revenue, a 10% increase over the prior year period and the sixth consecutive quarter of double-digit revenue growth. Windows and Windows Live Division revenue came in at $4.87 billion, a 2% increase over the prior period, in line with the PC market. They indicated a continued cloud momentum led by Office 365 and Xbox Live. In Windows and Windows Live Division, emerging markets continue to outpace developed markets. The PC market grew 1-3 % and business PC growth of 5% rose to a record high of 35million PCs in the quarter. Consumer PCs were flat, largely impacted by weakness in netbook sales. Total OEM revenue growth in the quarter grew 2%. Bing market share rose to14.7%, up 3.5% year over year. Bing-powered U.S. search share, including Yahoo! properties remained at 27%.

On the conference call, Microsoft indicated they continue to see broad-based demand across geographies, including Europe. That's good to hear. The company saw revenue growth across all segments with early success of Office 365 surpassing all expectations. The enterprise services continue to grow rapidly and the PC growth in emerging markets significantly outpaced growth in developed markets. They also indicated that multiyear licensing revenue should grow mid to high single digit for Q2 and low double digits for full year 2011. Doesn't sound like a double dip recession is coming any time soon to Microsoft.

With the stock trading sideways and still down significantly from the 2000 highs, Microsoft's valuation only gets better and better. Currently the stock trades for 9 times earnings, 8 times next years' earnings, 3 times sales, and 3 times book value. It's very rare to be able to buy a blue chip tech titan trading for less than 10 times earnings yielding over 3%. If the stock continues to move sideways the next 10 years it still beats the 10 year US Treasury, and let's be honest, Microsoft's balance sheet is a heck of a lot better than the US governments. Investors looking for a blue chip name with a great balance sheet and great prospects with a 3% dividend yield would be hard pressed to find a better stock than Microsoft.