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Jason said:
Great post, Kevin. Welcome to the team. As Kevin states above, he posts regularly at http://hipegg.blogspot.com under the pseudonym Jym Khana. I’m a huge fan of Kevin’s writing and his investing style: find great companies with strong fundamentals and use technical analysis to determine when to buy and sell. I hope our readers can learn as much from Kevin as I have.
I will confess that I was the one who posed the question above to Kevin. It’s no secret that Frank and I have been following MSFT stock. I sold my shares a while ago, waiting for the stock to bottom out and failed to execute when MSFT was below $22. My lesson would be: when you’re following a stock, it’s important to actually follow the stock. Being easily distracted can be fun, but it’s not good for investing.
In any case, I think Microsoft has a very interesting year ahead of them.
# 7 July 2006 at 10:11 am

Vince said:
Welcome to the team, Kevin.
I get all these Motley Fool email. Most of them annoying pitches to subscribe to their newsletters. But here’s their take on MSFT: (I apologize for the length of this comment, but all of it is valuable counter-point)
Short-timer’s syndrome
The biggest problem facing Wall Street is that its primary job is managing other people’s money. When a company looks as though it won’t be living up to previous expectations, its shares adjust downward accordingly. (That’s Wall Street lingo for “fall off a cliff.”) Professional money managers don’t particularly like being caught holding such a hot potato. It can ruin their reputations and raise the risk that the investors whose money they’re managing will take their remaining cash elsewhere.
As a result, when a company lowers guidance, its shares will often drop much farther than its new reality would justify. This is particularly likely when a company announces that its pain is due to significant investments for its future. It seems to be happening right now, in fact, to technology juggernaut and Motley Fool Inside Value selection Microsoft (Nasdaq: MSFT). In its most recent earnings report, Microsoft guided lower for 2007, largely because of its plans to invest an additional $2 billion to grow and protect its business.
Wall Street saw the announcement, noticed the $2 billion price tag, and immediately knocked Microsoft’s shares into the cellar. Its shares traded around $27.25 immediately before the announcement, dropped as low as $24.09 in the next session, and it ultimately fell to $22.73 in the following weeks. All told, more than 16% of the company’s market cap evaporated, largely because of that announcement and the company’s lowered near-term guidance.
The long-term view
Yet shareholders who cared about the long-term health of the business cheered the news. After all, Google (Nasdaq: GOOG) and its GooglePack present Microsoft with a credible, well-capitalized, motivated, and profitable competitive threat, the likes of which it hasn’t seen in quite a long time. Unlike Sun Microsystems (Nasdaq: SUNW), whose forays into free software and platforms distracted it from its own ailing business, Google’s core ad-based model has been profitable from the beginning. In addition, Google is fighting from its own position of strength as the dominant global search firm. Until that press release, I was beginning to wonder whether Microsoft’s years of dominance had made it soft. This announcement of increased investment let me know that the company still had some fight left in it.
That was important news to hear. After all, we’ve seen what happened to other former near-monopolies who refused to adapt to the world around them. The original AT&T (NYSE: T), for instance, absolutely buckled under competitive pressures, ultimately finding rescue through an acquisition by its former spinoff, SBC. Xerox (NYSE: XRX), once synonymous with the act of making a photocopy, has stagnated for decades since other firms muscled in on its turf. Even the once-mighty General Motors (NYSE: GM) is a tiny shell of its former self, with junk-rated debt, ever-shrinking market share, and mounting losses.
It’s true that $2 billion is a large chunk of money, and it’s also true that Microsoft kept mum on its exact plans for that cash. Even so, consider that Microsoft has some $34.8 billion in cash and short-term investments on its balance sheet, and threw off nearly $16 billion in free cash flow over the past year. If there’s a company capable of absorbing $2 billion in additional investment, it’s Microsoft. If there’s a company that needs to make that kind of investment to avoid the fate of so many failing former near-monopolies before it, it’s Microsoft as well.
Profit from the conflict
As much as we individual investors would like to think otherwise, Wall Street and its short-term opinion determine a stock’s current price. When its opinion turns so solidly negative against a company with such substantial long term potential, you can profit from the situation. Simply by realizing that the long-term future looks brighter than the short-term pain, you can buy and wait out the rough spots. Eventually, the market will forget its jitters and return the stock to a price closer to its true worth. This investing style is precisely what we use at Inside Value, and it’s a major reason why our service is handily beating the market, despite investing largely in firms once given up for dead.
Microsoft’s $2 billion investment could indeed hamper its earnings over the next fiscal year. Yet if that money is properly deployed, it will help reinvigorate and reenergize the largest, most powerful software firm on the planet. As the company benefits from the longer-term returns on those invested dollars, the investors who bought when things looked their worst on Wall Street will stand to profit the most.
# 7 July 2006 at 10:26 am

Vince said:
Just to add a bit more information ….
1. I neither endorse nor reject Motley Fool’s pitches for their newsletter service. I do find some of their essays interesting and sensible
2. I do own MSFT myself through a recent purchase. (for disclosure)
# 7 July 2006 at 10:35 am

awardtour said:
The $2 billion expense seems even less of a worry when you consider that MSFT’s net income went from $8 billion to $12 billion in just the last year.
I’d buy if I didn’t think there is potential for Vista to be a flop.
# 7 July 2006 at 11:29 am

Vince said:
The problem is that 16% of Microsoft capitalization was wiped out in those few weeks because of the $2Billion expenditure plans and the lower guidances. I’m sure Vista and the many other MSFT negative publicity didn’t help, but it was not the cause for the slide. So was it an overreaction? I’m not one to believe in market efficacy.
# 7 July 2006 at 12:19 pm

Kevin Hamrick said:
The Motley Fool post is excellent, thanks for sharing. They are basically saying that they are value investors which is great. I like the mention of GM once being a monopoly.
If you ask me do I believe that MSFT will still be around as a major player in 5, 10 or even 15 years I would say that the chances are good. Unlike GM, MSFT’s products can’t be easily replaced. If a large company wanted to change their IT infrastructure, it could take years, cost a fortune and possible lead to lost revenues when new systems fail. By contrast, it is almost a trivial matter for the same company to switch their service fleet from GM cars and truck to more fuel efficient, cheaper to maintain Toyotas.
My only concern with MSFT in the short term is that I am not convinced that they have reached the bottom yet or how long it will take them to get there. Certainly, a long term investor should end up profiting by buying now. He just might have a few sleepless nights waiting for it to turn around.
# 7 July 2006 at 3:52 pm

Chris said:
I did a fundamental analysis of Microsoft (MSFT) on May 4th. At that time I priced the company at $30.5, meaning that it may be possible to pick up 25% on this stock.
There are two caveats: Sales growth is slowing, with only 8% growth in the previous year. Also, be weary of rapid growth spurts in EPS when sales growth is slowing. EPS growth over the last 5-year period is only 5.7%. This indicates that EPS may just be catching up to where it should be, and may also be a result of short-term cost savings.
I think that as the date of Vista launch approaches you’ll see valuations rise. Based on the current Stochastics and MACD, though, it looks like a buying opportunity is coming up quickly as they indicate falling prices approaching.
Also, see our forum thread on MSFT.
# 8 July 2006 at 12:52 am

avi said:
Clearly MSFT is in the process of transforming from primarily a software company to a media company. It seems as if they have retreated for some time to rebuild – (hence slow growth, and a stagnant stock price). Their rivals and competitors seem to be getting stronger as the beast struggles to reinvent itself. But I’m convinced that the this day will ultimately come – when they wake up from hibernation and release new products that can capture the marketshare that they are accustomed to. This lone man thinks MSFT is a good long term solution.
# 8 July 2006 at 3:37 pm

Vince said:
Mr. Market is Jeykll & Hyde, what can I say?
For those following the MSFT story, I’m not sure if you’ve read this yet today?
http://blogs.barrons.com/techtraderdaily/2006/07/20/microsoft-msft-gets-richer/
Yeah, the market is inefficient as heck (my opinion)!
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