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Has Microsoft Become the Perfect Stock?

Sunday - 3/24/2013, 2:45pm  ET

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock and then decide whether Microsoft fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Microsoft.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

4.7%

Fail

 

1-year revenue growth > 12%

1.2%

Fail

Margins

Gross margin > 35%

75.4%

Pass

 

Net margin > 15%

21.2%

Pass

Balance sheet

Debt to equity < 50%

19.6%

Pass

 

Current ratio > 1.3

2.81

Pass

Opportunities

Return on equity > 15%

22.6%

Pass

Valuation

Normalized P/E < 20

14.81

Pass

Dividends

Current yield > 2%

3.3%

Pass

 

5-year dividend growth > 10%

15.4%

Pass

       
 

Total score

 

8 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Microsoft last year, the company has kept its eight-point score for the third year in a row. But the share price hasn't held up well, falling nearly 15% over the past year.

With its reliance on the declining PC industry, Microsoft has long known it needs to get into mobile devices. But so far, Microsoft's attempts to become relevant in the mobile space have had mixed success at best. The original version of the Surface tablet has posted disappointing sales, and although the Surface Pro has more promise as a full-featured device with the capability to run Office and other popular software, its price may prove too high to lure all the customers that Microsoft needs to tap for the platform to reach its full potential.

Even Microsoft's core business isn't as healthy as it used to be. The much-anticipated new Windows 8 operating system has emerged to lackluster sales, as hardware manufacturers haven't taken advantage of its full capacity, opting instead to focus on the faster-growth opportunities in smartphones and tablets. Some analysts believe that Microsoft's moves to get into the tablet market have alienated the companies that would typically rush to release new PCs with Windows 8, as Hewlett-Packard has opted to launch an Android-based tablet and a Chromebook so far this year.

Meanwhile, Microsoft appears to be adapting to the cloud with its Office software, as the company's divisional president in charge of Office said the package could eventually be sold entirely through subscriptions rather than in full-blown permanent licenses. Salesforce.com has had substantial success with its own subscription model, and subscriptions would remove the uncertainty that Microsoft suffers in predicting when users will pay for upgrades.

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