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Is a $7 Hike Likely in 2013 for This Tech Stalwart

Saturday - 11/17/2012, 10:15am  ET

Microsoft  is dealing with a number of issues currently, from the sudden and unexpected departure of Steven Sinofsky, to the lukewarm reception for Windows 8, the continued decline in demand for PCs, and the patent trial with Google over licensing for its technology. Investors should look carefully to determine if this is a stock which should be added to their portfolio.

Microsoft has about 8.4 billion shares outstanding and has a market capitalization of $226 billion. It is currently trading around $26.50 from a low this year of $24 and a high of $33.

Microsoft has a PEG Ratio just over 1.0 and seems to be fairly valued by that measurement. Here are some key statistics to compare Microsoft to the Application Software Industry and the Technology sector:

  1. Price/ Earnings is around 15 compared to 17.5 and 19 for the industry and sector respectively.
  2. Return on Equity is around 24.5% compared to 25% and 14% for the industry and sector respectively.
  3. Dividend Yield is around 3.2% compared to 2% and 3.4% for the industry and sector respectively.
  4. Price to Book is around 3.4 compared to 10.5 and 5 for the industry and sector respectively.
  5. Net profit margin is around 28% compared to 23% and 11.5% for the industry and sector respectively.
  6. Price to free cash flow is currently around 33 compared to 20.5 and 32 for the industry and sector respectively.

Specific Issues

Investors were surprised when Microsoft announced the resignation of Steven Sinofsky on Monday, Nov. 12. Mr. Sinofsky headed up the Windows 8 team and was purportedly the heir apparent to Steve Ballmer, current CEO. This has left the company in a bit of a flux, and the stock has taken a big hit, falling more than $1.50 in two days on relatively high volume. Long term, however, I don't see this as a huge issue. Mr. Ballmer and the rest of the executive team surely have a "number three" in their back pocket, and will begin the task of properly grooming him or her. In the meantime, Mr. Sinofsky's Windows hardware and software position has been filled by Julie Larson-Green, while Tami Reller will continue as CFO of the Windows division. In addition, word on the internet is that Mr. Sinofsky did not engender a cohesive team. Former Microsoft employee Hal Berenson was not surprised by Sinofsky's departure and shares his thoughts about the resignation on his blog this week.

Looking forward, Microsoft continues to take advantage of the sliding demand for higher-end and larger PCs by rolling out its entry in the tablet market. However, the introduction of the slick new Surface last month has been met with mixed reviews. Cheaper than the iPad, it IS a Windows device and many people prefer Windows over iOS. However, reviews indicate that it doesn't appear to be as well made as the Apple (AAPL) tablets, and supply is not consistent. Chip maker Intel (INTC) seems to be more affected by the downturn in PC demand than Microsoft.

Last month's Windows 8 release has been met with a tepid response. It appears that many users miss the Start menu, purchasing a third party application which restores it. The user interface is quite different from Windows 7 or XP and many people are having a hard time adjusting to the new appearance. Here is an interesting article from a self-proclaimed Windows fan who downgraded from Windows 8 back to Windows 7. Many user reviews (and Sinofsky's abrupt departure) seem to show that this is just the tip of the iceberg. On the up-side, some are saying to give Windows 8 a good long trial before making your decision. PC maker Dell  says it will continue to offer Windows 7 as long as "it is allowed to." Dell Director Alison Gardner goes on to state that Dell is "still moving our business customers from XP to Windows 7."

Finally, Microsoft's patent license trial with Google's  Motorola Mobility began on Nov. 13 in Seattle. Microsoft has claimed that Google is asking too much for its use of Motorola's patents for 802.11 wireless and H.264 video technology. Historically, Microsoft has argued that $1 million annually is a fair price to pay for this technology used in the Xbox and smartphones. Motorola has maintained that the patents are valued closer to $4 billion. The Seattle Times among others is covering this story.

Bottom Line

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