For anyone who grew up when personal computers were still in their infancy, Microsoft (MSFT – Free Value Line Report for Microsoft) is a well-known name. The company’s storied past and dominant market position literally came into being within the last 30 years or so. This was the quintessential growth stock. The important word in that last sentence, however, is “was”.
There have been several rounds of market favorite tech companies since then. The so-called dot.com bubble and burst, for example, and now the social media frenzy with Facebook’s (FB) initial public offering capping an already massive outpouring of interest in public social hubs, like Linkedin (LNKD). Microsoft is now the old man on the block, the aging slugger who lumbers to bat—still capable of hitting home runs, but whose fame rests more on the past than on his current abilities.
This lumbering giant, however, is still a formidable player. In fact, with a $256 billion market cap (found in the Capital Structure box), Microsoft is part of a unique group of international mega-cap companies. Its strength lies in the Windows operating system, which made up 27.2% of fiscal 2011 revenues, and the Office productivity suite, which made up 31.7% of revenues. Two products that are old, but entrenched. (This information is contained in the Business Description box.) Clearly, those two product groups aren’t the total, but they are half the pie. Its successes beyond these two areas are less impressive.
With revenues of nearly $70 billion in fiscal 2011, which can be seen in the historical portion of the Statistical Array, Microsoft clearly isn’t washed up. In fact, earnings continue to head higher at an impressive clip. Although the year-by-year statistics clearly demonstrate this, the actual magnitude of the increases are similarly impressive. The Annual Rates box shows the annualized earnings growth rate over the trailing five- and ten-year periods, which are 14% and 13%, respectively. That is fairly impressive for a company the size of Microsoft that’s no longer “hip” in the technosphere.
Looking to the future, Value Line analyst Charles Clark is projecting the company’s growth in earnings will slow down to an annualized 11%, which is still a decent clip. With that outlook, Clark believes the shares will trade in the $50-to-$60 range over the next three to five years. That translates to a share price gain of 65% to 95%. Throw the generous 3.1% dividend yield into the mix and projected annualized total return clocks in at 15% to 20%. (These figures can be found in the Projections box.)
That dividend, however, is a key part of the story here. Microsoft’s share price has been range bound since the early 2000s, which is clearly visible on the Graph. Even though revenues and earnings have advanced considerably over that time, dividends, which were first instituted in 2003, have increased at an impressive rate, too. At this point, Microsoft is not just a mature tech giant, but, because its shares have been range bound, it is also a member of the Dogs of the Dow—if you started the yearly rebalancing process of that investment approach today.
For those old enough to remember the glory days, this looks like a big letdown—technology phenomenon to the old guy on the block. However, to those following the Dogs of the Dow, this looks a lot like the type of value play the system is supposed to highlight. There are times when rote systems turn up companies in the midst of corporate turmoil; these can be hard to stomach, though very profitable if fortunes turn or the shares rebound on nothing more than a hope and a prayer. This isn’t the case for Microsoft, which is the type of company that you would want to own.
Clearly, the tech giant is not the creative force for change that it once was, but that’s not a bit problem. It still has important products, plenty of financial muscle, and what looks to be a solid future. What has changed is the market’s perception. This has led to Microsoft being relegated to the “dog house,” so to speak. In fact, it’s trading at a relative P/E that is lower than its average annual P/E during the 2007-2009 recession (average annual P/E can be found in the Statistical Array, while recessions are denoted by gray bars on the Graph).
The recent relative P/E was 0.72, which is well below the market’s valuation. The recent dividend yield was 3.1%. Both statistics can be found at the top of Value Line’s research reports. Moreover, Clark expects that dividend to continue to increase at an over 10% clip, annualized, for the next three to five years. Income investors with a focus on dividend growth would be well advised to take a look at this tech giant. With a 3.1% recent yield, even those seeking current income, particularly in today’s market, might consider this issue, noting that Microsoft is, for the moment anyway, a Dog.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.