Marcial: Microsoft, Google Good Bets

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Microsoft has long been underappreciated by the Street and by investors. Sass figures the stock, currently trading at a price-earnings ratio of 14, is cheap based on the company's expectations of yearly double-digit growth in 2008 and 2009. Revenue growth is projected at 14% to 18% over the next two years, says Sass. In the current difficult economic times, Microsoft and Google are both doing fairly well, he adds.

Microsoft should continue to gain market share in software, generating 60% of its revenues in foreign markets. Excluding any deal with Yahoo, Sass expects Microsoft stock to hit $40 in a year. Should Microsoft bag Yahoo, that would be a big positive for Microsoft shares, says Sass. Some analysts worry that the potential integration challenges in buying Yahoo could generate headaches for Microsoft, in part because of a dilution in earnings. But they agree that the hostile bid for Yahoo makes strategic sense to jump-start Microsoft's online presence with consumers, advertisers, and publishers. It would enable the software giant to "better monetize its online assets over time," says Brad Reback of Oppenheimer (OPY).

Buy Recommendations

One of the bulls on Microsoft is Jim Yin of Standard & Poor's (MHP), who hoisted a strong buy recommendation based on the fundamentals even before the offer to acquire Yahoo. His positive rating is based on his expectation of higher sales of PC units from the launch of Windows Vista and the stock's relatively low valuation. His 12-month target for Microsoft (without Yahoo) is $43 a share.

Mark Murphy, managing director at Broadpoint Capital, who recommends buying Microsoft shares, supports its move to acquire Yahoo. The deal would change the global Internet search and advertising landscape so that it would essentially comprise just two major players. "A fragmented market would become a duopoly overnight," says Murphy. With Yahoo, Microsoft would gain enhanced engineering talent to drive innovation, he adds. Internet advertising depends upon scale and requires massive capital investments to build a global platform, and Microsoft could add to Yahoo's strength.

Google: An Opportunity as Well

And why buy Google? Even with a combined Microsoft-Yahoo to confront, Google will continue to have an edge in the search business, with a 75% share of the global paid-search market and 65% of the U.S. paid-search business. In Europe, Google's advantage is even bigger, with its 85% slice of the pie. "Google remains a very attractive long-term growth stock," says Sass, who forecasts earnings of $19 a share in 2008 and $23 in 2009, vs. 2007's $11.78.

Rob Sanderson of American Technology Research, who rates Google a buy, believes strongly that Google has several years of "exceptional growth ahead." With the stock's slide after some investors bailed out following disappointment with the recent quarterly earnings, and Microsoft's bid for Yahoo, Google represents a buying opportunity, argues Sanderson. Neither event changes the opportunity for Google to grow strongly for a number of years, he adds. His 12-month target for Google: $750.

Any time a value play like Microsoft and a growth stock like Google weaken in price, the opportunity to buy them should be considered a gift, especially if you are a long-term investor. With or without a Microsoft-Yahoo combination, both Microsoft and Google will be considerable winners in the years ahead. Of course, with Yahoo, Microsoft will be a more challenging rival for Google. That in turn will undoubtedly push Google to move aggressively to widen its lead over the Microsoft-Yahoo combo. Who would end up the loser? Investors who fail to buy into Microsoft and Google now.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.