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Bonds Are a 'Safe' Investment: A Big Lie Gets Even BiggerMoney manager and newsletter advisor Jim Stack, well-known for his safety-first strategy, recently added Microsoft (NASDAQ: MSFT) to his model portfolio, noting, "We had wanted to increase our allocation to technology which has typically been a leading sector in new bull markets."
In his InvesTech Market Analyst, he explains, "This stock exhibits all the qualities we look for in a new purchase and is currently selling at a very attractive valuation."
"From its founding in 1975, Microsoft has become the world's largest software company with offices in over 100 countries. Its Windows operating system –which runs on 90% of all PCs currently in use – and for the Windows Office applications utilized by over 400 million users.
"This firm is extremely profitable with company-wide operating margins in excess of 40%. The Windows operating system and Office productivity suite have operating margins averaging closer to 70%.
"The company is completely debt free and generates over $1 billion in free cash flow each month. Management has done an excellent job of utilizing shareholder capital with a return on equity of over 40% compared to an average of 15% for S&P 500 companies.
"Additionally, the company's global presence, with two-thirds of revenue generated outside the United States, helps to mitigate the effects of a domestic recession. The company's enviable profitability and lack of debt produce a very strong balance sheet.
"Even after paying a $32 billion special dividend in 2004 and buying back $47 billion worth of stock over the past two years, Microsoft still holds $31 billion in cash and long-term investments.
"Microsoft retains over 75% of earnings, but it initiated a dividend in 2004 and has increased the dividend each year. Although the stock currently yields just 1.5%, this is high relative to its peers.
"Identifying a great company for investment is only half the process... our goal is to purchase the stock at a discount to fair value. Microsoft's valuation metrics – including price/cash flow, price/revenue and price/earnings – are all at their lowest levels of the past 20 years.
"In fact, although the stock price remains the same as in late 2002, the company's sales have doubled and earnings have increased 50% during this time frame. At the current price, Microsoft offers a great opportunity to buy an excellent company at historically low valuation levels.
"While there is much to like about Microsoft, there are obviously business risks. Perhaps the biggest challenge is the firm's need to adapt to the developing 'software-as-a-service' segment of the industry.
"With this business strategy, software is delivered on demand via the Internet and paid for by subscription, traditional licenses or even provided free of charge and funded by online advertising.
"This is one reason why online advertising is so important to the Microsoft business model moving forward and why they tried to acquire Yahoo! earlier this year. Talks have continued since Microsoft officially withdrew its bid in early May and there may ultimately be a partial acquisition or partnership created.
"While such an agreement would likely be dilutive to earnings in the short-term, the fact that Microsoft has such a strong financial position and can afford these investments represents a distinct competitive advantage over smaller players.
"Overall, we feel Microsoft is a solid choice for a 'safety-first' investment in the technology sector. With the stock currently trading at less than $30/share, we believe it has significant upside potential and lower-than-average risk in an otherwise volatile sector."
Each day, Steven Halpern's TheStockAdvisors.com offers the latest market commentary and favorite investment ideas from the nation's leading financial newsletter advisors.
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