Can Windows 7 'Reset' Microsoft Shares Higher?

Applause for Windows 7, cost-cutting, and an earnings surprise have stirred hope that Microsoft's stock will revive. Will businesses buy the upgrade?

By Aaron Ricadela

A well-received debut for its newest operating system and fresh signs that businesses again want to spend on computers gave Microsoft investors reason to hope a more than yearlong sales decline is coming to an end. But it may take big spending by consumers to pop Microsoft stock out of its tight trading range.

Shares of Microsoft (MSFT) gained 1.43, or 5.4%, on Oct. 23 to close at 28.02. Before the market opened, the company reported fiscal first-quarter sales and profit that bested analysts' forecasts. Revenue fell 14% and profit dropped 18%, but Wall Street analysts had expected worse. "The fourth quarter of fiscal 2009 may well have been the bottom on the economic reset," Microsoft Chief Financial Officer Chris Liddell said during a conference call with analysts. He was harking back to remarks by other Microsoft officials, who have said that old demand patterns have been "reset" lower amid recession and a credit crunch.

As heartening as recent gains may be, Microsoft shares remain in the mid-20s range, where they've been mired for a couple of years. An investor who bought Microsoft shares in late October 2000 and held them would have realized a net gain of about 1%. The shares reached about 37 in November 2007, but then declined to about 27 by February 2008. They've barely budged since. Despite Microsoft's size and influence—the company reported $58.4 billion in sales last year—its stock has lagged the tech industry's highfliers.

Apple (AAPL) shares closed at an all-time high of 205.20 on Oct. 22 after the company reported a blowout 47% increase in quarterly profits on Oct. 19. Amazon.com (AMZN) shares reached a record high on Oct. 23, closing at 118.49, after it reported a 68% jump in third-quarter earnings a day earlier. And Google (GOOG) is trading at a lofty 554, although the stock is well off its high of 715 in late 2007.

PC Sales Stalled in First Quarter

Getting consumers to embrace Windows 7 and snap up more capable computers than the low-end mini-laptops that have accounted for the PC industry's meager growth will be key to Microsoft's earnings and stock performance, analysts say. The difficulty of forecasting consumers' fickle buying behavior is one reason Microsoft isn't releasing a specific sales or earnings target for the current quarter. "The financial impact of [Windows 7] will be driven by the consumer market, and that's very hard to predict," says Yun Kim, an analyst at Broadpoint AmTech (BPSG) who has a buy rating on Microsoft shares.

During the fiscal first quarter, sales of consumer PCs rose at a single-digit pace while those of PCs for businesses dropped at a double-digit rate, Liddell said.

Business demand will need to reverse course and consumer buying will have to accelerate. A "wildly successful" year of Windows 7 sales could propel the stock to 33 and put the company's price-to-earnings ratio on par with the rest of the tech industry, Kim says. That will likely only happen if Microsoft can increase sales and earnings by more than 10% a quarter. "If they can grow by double digits, there's a lot of room for this stock to go higher," Kim says. "There aren't many companies doing that anymore."

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