Monday, February 07, 2005

Growth or Value?

Two weeks ago I wrote up a report on AT&T and last week I wrote up a report on WMT. The AT&T advice didn't really work out since they got bought out pretty quickly after my report. Do you think SBC Communications was reading what the Soothsayer had to say? (I doubt it too!) We are still waiting on WMT to break out, but they had a pretty good last quarter. I've also written up a report over at that you should peruse on Kos Pharmaceuticals.

This week I am going to write up the stalwart of technology companies. This company is the world's largest software company at an astounding $284.8 billion market cap. That's right...I'm talking about Microsoft. I see capital appreciation in the future for Microsoft and I wanted to share my views.

Microsoft isn’t a value stock as Mr. Graham would describe it, but it is a big cap with some value. Can you believe Microsoft has zero debt...absolutely none? That seems impossible in this day and age, but it is true and it’s been true for the past 9 or so years. They have a strong balance sheet and a definite market leadership position. This is one for the long-term portfolio.

Microsoft has several different businesses. They have their client software business, which is their largest at 31.4% of sales, information worker software (29.3%), server products (23%), Home and Entertainment (7.8%), MSN (6%), Business Solutions (1.8%), and their mobile business (.7%). Here is what Standard and Poor have had to say about each segment of their business:

“MSFT’s Server and Tools segment consists of server software licenses and client access licenses for Windows Server, SQL Server, Exchange Server, and other servers. Windows 2003 Server is the latest release for an operating system for servers, to help build and deploy distributed applications for networked PCs.

“The Information Worker Segment is responsible for developing and delivering technologies that focus on improving productivity for information workers in corporations. Office suite, which includes the popular Word (word processing), Excel (spreadsheet), PowerPoint (graphics), Access (database management) and Outlook (messaging and collaboration) software programs, dominates the application software market just as Windows dominates operating systems. MSFT Office System, the latest version, was introduced in October 2003.

“The Business Solutions segment includes the businesses of Great Plains, bCentral and Navision. The segment develops and markets a wide range of business applications designed to help small and mid-market businesses become more connected with customers, employees, partners, and suppliers.

“The MSN segment includes MSN Subscriptions and MSN Network Services. MSN subscription services include MSN Internet access, which provides dial-up Internet access, and other premium services. MSN Network Services, which provides services on the Internet, including MSN Search, Messenger, and Hotmail. Partners include ESPN, Expedia, and MSNBC.

“The Mobile and Embedded Devices segment consists of Windows Mobile software, Windows Embedded device operating systems, MapPoint, and Windows Automotive. Windows Mobile software powers Pocket PC, Pocket PC Phone Edition, and Smartphone products.

“The Home and Entertainment segment includes the Xbox video game system, PC games, the Home Products Division, and TV platform products.”

That’s a diversified revenue stream!

According to the Value Line Research report, “Demand for the company’s server products is especially strong, and that should continue to be the case as it rolls out applications to help users better manage their systems.” Along with their tried and true businesses, where I think Microsoft is still in the growth phase is in the home entertainment portion of their business.

To establish the Windows PC as the hub of home entertainment, Microsoft is building technologies into Windows that improves the PC’s ability to work with digital audio and video. MSFT and its partners are also creating a wide variety of entertainment products and services, from portable audio players to online music stores, that support this role for the PC. The Xbox and Microsoft TV are basically hedges against market changes that could reduce the PC’s relevance in the home, but there are definite long-term opportunities in both businesses as well.

Microsoft is looking for 8%-10% PC growth worldwide driven by improving corporate demand, which should translate to continued better results. Their newer products like the Internet TV software, Xbox, SQL Server, and MSN should increase growth in the future.

So, let’s take a look at some of the value criteria that Benjamin Graham was so fond of:

P/E 27.17 = No, the Benjamin Graham criteria would require a P/E below 20

Price/Book 3.74 = No, the BG criteria requires a P/B below 1.5

Current Ratio 2.95 = Yes, BG criteria requires a CR of at least 2

Intrinsic Value $33 = Yes, BG criteria requires IV to be at least 15% higher than the current price

Revenue Growth 23% (10-YR Avg.)= Yes, BG criteria requires at least 15% revenue growth

Yield 1.2%

You can see that by passing only 60% of our BG criteria that MSFT is not on the strict value investor’s radar. Checking over at on their Guru page we can see that Microsoft passes 57% of their BG criteria.

Value investors will however like MSFT’s new outlook on dividends and giving back to the investor. Not only has MSFT’s raised it’s dividend to $0.32/share, but they have also agreed to a share repurchase program. They have agreed to a $30 billion stock repurchase program commencing over the next four years. This should give the long-term shareholder something to cheer about.

I have given my fundamental reasons for a long-term purchase of MSFT shares and now I will look at MSFT technically to find support and resistance areas for an intelligent area of accumulation. As always we will start with the monthly view.

Click to Enlarge the Monthly Chart Posted by Hello

The most noticeable technical attribute on the monthly chart is the extremely long flat top ascending triangle. The triangle begins in December of 2002. Microsoft has already broken out of a few downtrend lines. One of those trendlines began in July 2000 and another that began in June 2001. The reason for not exploding out of these trendlines has been the uncertainty of the antitrust litigation. That is now all behind Microsoft…for now.

Click to Enlarge the Weekly View Posted by Hello

The first weekly view here gives us a better idea of this "flat top triangle", which might not be a flat top triangle at all. The upper trendline is not as flat as it seemed in that monthly view. What I know is that once MSFT breaks above that upper trendline, it's basing will be over.

We can also see some fine support at its current price level. MSFT has two uprending lines and the 50 and 200-Week MA's for support. There is some definite support in this area. Stochastics and RSI seem to be trending upward, which is nice.

Click to Enlarge the Weekly View Posted by Hello

On this next weekly chart I wanted to show you the on-balance volume (OBV). You can see that it has flattened out and has now begun to correct upward. This tells us that there is now some money coming into this stock.

Click to Enlarge the Daily View Posted by Hello

Looking closer at our triangle, we can see that MSFT is having some trouble with the 50-day MA. I don't believe this level will be a problem to break through. The weekly view is telling of higher prices ahead and it always trumps the daily view.

In summary, I would purchase a half position at this point and wait to purchase the other half once MSFT breaks above the upper trendline. Microsoft is in good shape financially and has now started to shape up technically. At these levels Microsoft is a good candidate for a long-term portfolio position. A more advanced strategy could be taken with the use of options.

Best Regards,

The Soothsayer of Omaha


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