Jun 6, 2011

Microsoft Corporation (NASDAQ: MSFT) and Windows 8 Are On Sale

There is a consensus in play right now in the technology sector and it could be very profitable for investors willing to get in now and position themselves for the revaluation of an opportunity. Microsoft has a dominant position in the technology industry and with Windows enjoying almost a 90% market share in the operating systems business and the Microsoft Office Suite camping on a big chunk of the professional software market, this company is poised to experience growing profits over the coming years.

Investors appear to be anticipating a big drop in the market share of the company because of the rising threat arising from sales of tablets. Analysts seem convinced that iPads and Android tablets will eat the market share of PCs, thus reducing the overall grasp of the market by Microsoft.

Lets take a closer look at what the future has in place for Microsoft. First, Windows 8 is in the pipeline and according to the teaser preview provided by the company last week, this version of Windows promises to be quite different from it's predecessors. If you haven't seen it yet, take a look on their official website here. Windows 8 seems more exciting and more intuitive, showing that the company is working to create products that are more in line with what the competition, namely Apple and Google, are currently doing. Also they are not just imitating their competitors, they are innovating and bringing something new to the marketplace. The big news with Windows 8 is that it will be compatible with the touch technology, we will therefore expect to have an announcement in the coming months of a Windows 8 tablet.

 EPS for 2011 is an estimate and data for 2012 and after are projections.
The current attractiveness of the company is phenomenal from a fundamental standpoint. Over the past 10 years, Microsoft has been able to grow sales by roughly 10% per year because of good pricing power and an average 4 year product cycle. Assuming the company can grow it's sales by 7% over the next ten years and that most other expenses grow in line with sales, we end up with a company valuation of 33$ per share. At current prices, this provide investors getting in right now with a 40% return as the market starts to realize how undervalued the company is. 

The recent price of 23.91$ implies that Microsoft will be able to grow EPS by only 3% per year over the coming 10 years! We know that in reality the company has been able to grow this metric by an average of 13% over the past five years.

Also, you are paid to wait, as the shareholders currently enjoy close to a 3% dividend yield and Microsoft certainly has enough cash on hand, even following the recent acquisition of Skype, to sustain a healthy growing dividend. Long term investors should see the current price levels of the company as a great buying opportunity.

Using a price-earnings multiples valuation, we also come to the conclusion that the company is undervalued. The P/E ratio of the company is currently at 9.47. Over the past fire years, the average P/E ratio of Microsoft was 16, with a high of  23.7, which doesn't seem very much out of this world. With a trailing twelve months EPS of 2.52, we end up with a price per share of 40$ using the five years historical average P/E of Microsoft.

In my humble opinion, EPS for FY 2012 of Microsoft will hover around 3$ per share as the company finally catches up with it's competition and sales of Windows 8 pick up. By using once again our historical P/E of 16, we come up with a stock price of 48$. It is clear that current prices grossly undervalue the profit potential of the company as it is able to generate an incredible amount of profits for it's shareholders.

As you can see, these two methods allowed me to come to an approximate value for the shares of Microsoft ranging from 33$ to 48$ one year from now with fairly conservative assumptions. Acquiring a position now will be very beneficial to shareholders as those intrinsic values allow them to reap substantial profits. There is very little downside left and any good news by Microsoft will have a positive effect on the stock price.

Full Disclosure: The author is Long MSFT

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