Monday, February 9, 2009

Marcial: Microsoft, a Compelling Value Play

Marcial: Microsoft, a Compelling Value Play

With savvy investment pros increasingly talking about the stock market circling toward a bottom, value and technology issues are getting the thumbs-up. After the drubbing they've taken in the past two years, the pros say, these sectors are poised to lead the parade when the market turns.

John Linehan, who manages asset manager T. Rowe Price's (TROW) $6 billion Value Stock Fund, says value stocks have become more compelling on the basis of their depressed valuations as measured by several metrics, including price-earnings ratios.

Investors could play the coming value-tech upturn by buying just one stock: Microsoft (MSFT).

The world's largest software company, with a market cap of $158 billion, is not only an undervalued tech stock but is also a safe and enticing value play, according to Linehan.

Buy or Hold

True, the stock has been a disappointment, having slid from a 52-week high of 32.10 a share on Apr. 24, 2008, to 16.75 on Jan. 23, 2009. But it has since edged higher, to 19 on Feb. 6, even after reporting disappointing earnings in January for its fiscal second quarter ended on Dec. 31, 2009. The company posted a profit of 47 a share on revenues of $16.6 billion, vs. analysts' consensus forecast of 49 on revenues of $17 billion.

Still, none of the 34 Street analysts who track Microsoft recommends selling the stock. In fact, 22 rate Microsoft a buy and 12 tag it a hold.

Linehan says Microsoft, trading at just 9.5 times his 2009 earnings projections, is undervalued because it deserves to trade at a higher price-earnings ratio. He figures that in a "normal" stock market, Microsoft merits a p-e ratio of 13 to 14. He expects Microsoft will earn around $1.85 a share in 2009 and $2.25 in 2010.

Microsoft is a compelling value stock play, says Linehan, in part because of its strong balance sheet. It generates free cash flow of about $1 billion every month and has $23.7 billion in cash and investments as of June 2008, even after paying out $116 billion in dividends and share buybacks in 2008. That suggests the stock's 3% dividend yield is pretty safe, he adds. Microsoft has also been slashing costs, including reducing its personnel count of 91,000 by 5,000,

A Smartphone Ahead?

Microsoft's new products, says Linehan, which include the new Windows 7 system, should attract fresh investor attention. Microsoft plans to launch the new version of its Windows operating system in 2010, followed by an improved version of the Office suite of applications. It is also moving into new fields, including cloud computing, where Microsoft runs its products on computers at its own data centers for customers without their having to purchase additional software.

Rumors are swirling that Microsoft plans to launch its own smartphone—a cell phone that features more advanced functions, including Internet access. A Microsoft smartphone would compete head-to-head with Apple's (AAPL) iPhone and Research In Motion's (RIMM) line of BlackBerry devices. If the new phone gains widespread consumer attention, Microsoft's stock could pop, at least in the short term.

Analyst Kevin Buttigieg of investment firm Stanford Group notes that in the past four years, Microsoft's stock traded at an average p-e of 19. The high was 23 and the low 15. While the economy has had a negative impact on Microsoft's operations, the stock's current valuation more than discounts this weakness, he argues. Buttigieg rates the stock a buy with a 12-month price target of 24.

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