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MARCH 7, 2003 STREET WISE By Amey Stone Microsoft: A Tech Stock for "Chickens" In this market, the Colossus of Redmond appears to be as close as it gets to an obvious pick for investors who like to sleep at night
In this gloomy environment, Microsoft (MSFT ) beckons to long-term investors. Thanks to a huge $43 billion cash horde and its lock on the PC operating system market, earnings growth and financial strength are virtually ensured. Meantime, due to a recent spate of worrisome, but not major, negative news at the company -- including new antitrust charges lobbed by competitors in Europe, software security breaches, and signs that Linux, a competing free operating system, is gaining ground (see BW, 3/3/03, "The Linux Uprising") -- Microsoft shares have fallen about 10% this year, closing as of Mar. 6 at $23.27. NEGATIVE ADVANTAGE? Many analysts see the dip as a buying opportunity. "Certainly it's difficult to pound the table on Microsoft shares, given the climate," RBC Capital Markets analyst Sarah Mattson wrote in a Feb. 26 research note. "But we believe investors should use the current negativity to build larger positions." Mattson thinks investor sentiment toward Microsoft will improve after March, and she has a $35 price target. Based on its earnings strength, at the current price Microsoft's stock is trading at a lower valuation lower than at at any time since the height of its U.S. antitrust legal troubles in 2000. Its price-to-earnings (p-e) ratio on its trailing 12-month profits is 27. That's higher than that of the benchmark Standard & Poor's 500-stock index, which is 23, but much lower than Microsoft's average 2002 p-e of 37 and its 2001 p-e of 48, according to data from Morningstar. (Microsoft's five-year average p-e is 55, but that period includes not only the stock-market bubble but peak years for profit growth and margin expansion that the software giant is unlikely to see again.) The stock looks even cheaper when you subtract its $43 billion in cash, which equals about $4 a share, says Richard Moroney, editor of the newsletter Dow Theory Forecasts. "Then, what you are really paying for the company is only $19," he says. That gives the stock a p-e that is less than 19 times estimated 2003 earnings, which is a small premium to the 17 p-e of the S&P 500. SPLIT SIGNALS. Beyond a pure valuation perspective, many analysts cite other reasons to be optimistic about Microsoft shares in the coming months. Redmond has some major new products coming out, including a new version of its server software, Windows Server 2003, in April and an Office upgrade early this summer, both likely to generate some buzz for the stock. Brendan Barnicle, an analyst with Pacific Crest Securities, believes Windows and Office upgrades could produce sales of up to $47 billion over the next two to three years. He rates the stock a strong buy, calling it in a Feb. 24 research note, "one of the safest bets in technology." Microsoft can also boast of making recent headway in new, faster-growing businesses, such as its Xbox Live online gaming platform (up to 350,000 subscribers in its first three months) and the Tablet PC (see BW Online, 2/26/03, "Tablet PCs: An Overnight Sensation"). Also noteworthy: Management has made some major pro-shareholder moves lately, which should attract new investors over time. On Mar. 7, shareholders received their first annual dividend payment. It was only eight cents per share, but Moroney expects Microsoft to gradually raise the amount. On Feb. 18, the stock split 2-for-1, to a price of $24.96. Deciding to split at $50 was a notable sign that management has confidence that the price will head north. All eight previous Microsoft stock splits took place when the shares were trading around $100 or higher. LIKE AN INDEX. None of this is to say Microsoft shares are likely to double any time soon. Mattson notes that the stock price has few near-term catalysts, and she worries that some analyst estimates for the next couple of quarters are too optimistic. The company said in January that revenue for the 2003 fiscal year, which ends in June, would be around $32 billion, profits at $14 billion, and earnings per share at 96 cents. Yet analysts' consensus forecast is for earnings of $1.02 a share for fiscal 2003. At about 14% for sales and 12% for earnings, that's not the kind of annual growth that used to get tech investors excited. Paul McEntire, manager of the Marketocracy Technology Plus Fund (TPFQX ) believes some smaller-cap names offer more opportunity for capital appreciation. Part of the problem, as he sees it, is that Microsoft's stock is so closely followed by so many investors and analysts that it's likely to be fairly priced. "It's a little like buying a tech index fund," he says. Even Moroney, who says Microsoft is his favorite tech stock, admits: "We are kind of chickens in that area." He thinks it could rise to $30 or $35 over the next year, not double or triple from here. "But there's something to be said for having at least part of your portfolio in something you can count on," he says. Many investors would agree. Of course, the stock could still fall from here if PC demand weakens, IT business spending slumps further, or general market conditions worsen. But to plenty of pros, Microsoft is looking increasingly like the safest tech choice in a risky market.  Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column Edited by Beth Belton Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. 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