Stock Pick of the Week: Microsoft

For those of us that use a computer, for business or personal use, this company needs no introduction. Microsoft (Nasdaq: MSFT), generates earnings through the development, manufacturing, licensing, and supporting a wide range of computer software products, such as its wildly successful Windows operating system and Microsoft Office. Microsoft also designs and sales the gaming system Xbox 360 and its accessories. It currently operates in 5 business divisions: Windows, Server and Tools, Online Services, Business, and Entertainment and Devices.

Strengths

Management

Although not considered to be the visionary like his predecessor Bill Gates, Steve Ballmer, who has been with Microsoft since 1980, and his staff have done an masterful job of consistently growing revenue, operating income, and net income in recent years. Management has also been able to have a strong return on equity of roughly 42% all while facing tough economic conditions and ever increasing competition from the likes of Google and Apple.

On top of the steady growth and high return on equity, Microsoft has also repurchased $170 Million in stock and are authorized to continue a $40 million buyback until 2013.

Products

Along with strong management, you have to look at Microsoft's product line. The Kinect, the motion game sensor for Xbox 360, sold 8 million units in 60 days. Demand will surely continue to be steady for Kinect as those who missed out at on the product during Christmas rush begin to get them in the upcoming months. Alongside the Kinect, Microsoft Office 2010 became the fastest selling version of Office in history and helped the the Business division revenue grow 24% year over year.

Windows has also recently released the windows phone 7 operating system in 30 countries through 60 operators and 9 different devices.

Weakness

The main weakness for Microsoft is the competition they face. This competition from Google, Apple and other software developers will effect the ability of Microsoft to provide future returns on equity as high as seen in previous years and also will slowdown growth prospects and profit margins.

Opportunities

The move toward cloud computing represents a major opportunity for Microsoft. The move has already begun with the development of Windows Azure and firms such as Pixar animations have shown possible uses of the platform. With the vast amount of cash reserves and a strong research and development department, Microsoft will be able to enter the area and quickly gain market share.

Threats

There will continue to be threats from Google and Apple in many areas in which Microsoft operates such as online search, cellular handeset operating system.

Valuation

Using Discounted Cash Flows with a 14 % growth rate (average of past 10 years) in the next 5 years, Microsoft has a fair value of $36.01 which is a 22% margin of safety from Wed. closing price of 27.94.

Investment Analysis

While not the superior growth machine it once was, Microsoft is still a company with solid growth, and strong and shareholder friendly management. With $41 billion in cash and cash equivalent it can still be seen as the 800 puond gorilla in the software space.