Investing

Microsoft Looks Cheap—as Usual


By many measures, Microsoft (MSFT) looks like a bargain. The company, which reports earnings on Apr. 28, has more than $40 billion in cash and equivalents, a lock on the personal-computer operating system market, and profit margins that most companies would envy. The stock had a price-to-earnings ratio of about 11 on Apr. 26, 29 percent less than the Standard & Poor's 500-stock index's p-e of 15.5. No wonder 26 of the 34 analysts who cover it rate it a "buy," according to data compiled by Bloomberg.

Yet the stock is stuck. It closed at 26 on Apr. 26 a price it first crossed in 1998—and close to its average of 27 since the start of 2001. For the 10 years through Apr. 22, the shares delivered a total return of -7 percent while the S&P 500 returned 30 percent. For all its apparent luster, Microsoft is suffering from an identity crisis. It doesn't qualify as a growth company because it has failed to come up with successful new products that would create rapid profit gains, the way Apple (AAPL) has. And with a 2.4 percent dividend yield, it isn't doling out enough cash to satisfy value investors. Microsoft is in danger of becoming a value trap—a stock that always seems to be selling for less than it's worth.

"Microsoft has spent 10 times what Apple has over the last decade, and the quality of innovation just hasn't been there," says Eric Jackson of Ironfire Capital, a hedge fund in Naples, Fla. The company has launched a series of products that failed to catch on, including the Zune music player, which will cease production this year. Its mobile operating system for Smartphones and tablets has made only a dent in markets dominated by Apple, Research in Motion (RIMM), and Google's (GOOG) Android.

"There's got to be a wake-up call coming up where shareholders will say, 'Do something!'" says Richard Doherty, head of Envisioneering Group, which advises tech companies. He says he's in touch with employees who resent that their shares have underperformed and how the company has missed out on big tech trends like streaming media and social networking. "You no longer work at Microsoft to get rich on stock options."

While the company has returned $170 billion to investors in buybacks and dividends in the past decade, some investors want more. Jackson says last summer he lobbied Microsoft Chief Financial Officer Peter Klein to increase the stock's quarterly dividend by at least five times what the company ultimately decided—a 3 cents hike, to 16 cents a share on Sept. 21. "I said that they needed to wake shareholders up to the value of a high-yielding stock like Microsoft," Jackson says.

The stock is up 4 percent since the dividend announcement, while shares of Apple, which pays out none of its $66 billion cash hoard, have increased 24 percent. IBM (IBM) has so deftly diversified out of the PC business that its shares are at an all-time high. Says Microsoft's general manager of investor relations, Bill Koefoed: "Over the long run, share price is indicative of earnings results, and we feel pretty good about our future prospects."

Value investor Whitney Tilson of T2 Funds has been a longtime Microsoft supporter. In his 2010 yearend letter to investors, Tilson wrote that the stock's valuation was "insanely low." In February he told his investors he was adding to his Microsoft stake. He took issue with what he called the "consensus view that Microsoft is a fading giant," saying "there is no current evidence to support it. Microsoft's market share in its key business areas is stable or rising, and sales, margins, and profits are growing nicely. We think there is robust growth in store for Microsoft."

Ironfire's Jackson isn't buying that argument. "They should embrace their strength—cash," he says. "And not pretend they are still a growth company."

The bottom line: Investors have not been rewarded for their faith in Microsoft, which has returned -7 percent over the past 10 years.

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Farzad is a Bloomberg Businessweek contributor. Follow him on Twitter @robenfarzad.

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