Since I first read “One Up on Wall Street” in the early 90’s, I’ve been an ardent fan of Peter Lynch’s “buy what you know” strategy for stock picking. Unfortunately, it’s taken a few years for the rest of the lessons in the book to have taken hold. So far, all of my “successful” stock picking has been done in virtual portfolios on the web. You see, the trick to investing is only half solved by finding the right companies to buy shares in. The really hard part, and perhaps the most difficult skill in business, is determining the right valuation for a business. Because of this, it’s very easy to fall in the trap of buying the right shares, but at the wrong price. (Picture is of Ray Ozzie, CTO of Microsoft, and former CEO of Groove Networks)
So I patted myself on the back the other day when I realized that as I get older, I am at least starting to ask the right questions. I spent about twenty minutes going over ratios and numbers for Microsoft, trying to decide if this is the right time to buy.
The reason I spent this time was that news from last week opened an excellent buying opportunity. As part of its earnings announcement, the company laid out plans for investing $2 billion dollars in R&D in 2007, a number far higher than expected by analysts. This means that Microsoft is reinvesting profits (spending their money) because they think they can make more by spending the money now. However, the immediate effect was that Wall Street saw that Microsoft’s projected earnings would be far lower for the coming year. Shares got whacked for 11% of their value, or $32 billion in market value. To give you an idea of just how big Microsoft is, that $32 billion would have been enough money to buy all of Costco (yes, the entire company). That’s a lot of money to lose in a matter of hours.
It’s very popular these days to follow Google, which is considered “the” growth stock of the tech sector these days. You’ll see story after story about Google challenging Microsoft’s dominance. I believe Google has a decent chance, but I’ve been in computing industry for a few years now, and one rule I continually come back to is – don’t bet against Microsoft.
As an investor (or “pho” one anyhow), I couldn’t go near Google with a ten foot pole right now. Trading at $408, Google just looks too expensive these days, not because of the $408 number, but because of it’s Price to Earnings ratio, which is at 71.95. That means, at 408 dollars, it would take you close to 72 years (at current earnings) to earn your money back. Of course, that in and of itself does not make Google a bad investment, it’s just one indicator. A lot could happen and will change.
No a better investment at this time (IMHO) is Microsoft, which because of this latest hit to the stock is trading at around $23, a P/E ratio of 18.7. Though a P/E ratio is best used as a comparable with companies in the same industry, a P/E of 18 is relatively low overall (at least for the tech sector – not some industries). For example, the five year high P/E for Microsoft is 57.41, which means MSFT is trading at one of its lowest prices in years.
So why buy Microsoft in the first place? There is a great little article in the May 15th Business Week called “Mixed Signals From Microsoft.” As one of the most widely held stocks in the world, investors are constantly watching the company for signs of what it will do next. Part of the current consternation (and the reason I patted myself on the back for asking the question) is what type of buying opportunity Microsoft currently represents. Investors like predictability, and as such, they like to classify stocks into “types.”
Microsoft is thirty-one years old, and in many people’s minds has passed the stage of “growth” stock and moved into more of a “value” type stock. This is why the market reacted poorly to the $2 billion dollar R&D investment. That indicates to the street that Microsoft still considers itself a growth stock. Microsoft is seen as a value investment that isn’t going to grow much more. Certainly it has some characteristics of a “cash cow” investment. Microsoft generates over one billion dollars in free cash flow…every month! The company is wildly profitable (incidentally, way more than Exxon Mobile).
So again, why buy Microsoft? Well, in my admittedly armchair opinion, Microsoft is still a growth stock. I wouldn’t bet against Microsoft yet and here is why. Number one, Bill Gates and Steve Ballmer are still in charge. Companies that are helmed by their original founders typically still are managed for growth. Number two, Microsoft is a “gamer,” they compete better than anyone, and they do so through big bets (see recent Fortune article about Ray Ozzie and Microsoft). Number three, well, in terms of revenue they can always grow. Microsoft had revenue of over $39 billion last year. A big number to be sure, but another computer company, IBM had sales of over $91 billion! Sure, IBM has a different mix of products, but Microsoft has proven its ability to move into additional markets in the past.
A disclaimer. It is likely too late for you to get fabulously rich from MSFT stock. It’s not going to climb another 61,000%, like it did from its 1986 IPO until now. However, as a solid, blue chip investment with good growth opportunity, I think Microsoft’s current price makes it buy.
