MSFT (NASDAQ)

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Microsoft Corporation (MSFT, NASDAQ)

One of the age old investment strategy is to buy low and when most think that the outlook can't get worse. This simple strategy could have made you quite rich without taking too much risk if you followed it rigorously, even in times when it was tough to eke out a return. The key to remember when embarking on such a bottom-fishing strategy, is to know well what the ultimate downside risk may be. Just a few months ago, if someone had told me that I will be analyzing Microsoft corporation as a candidate for bottom fishing, I would not have believed it. But as luck would have it, here we are.

You know what Microsoft is famous for, its windows operating software and a number of applications that run on this platform. These two businesses account for approximately 40% each of the company's revenues and the balance 20% is in other consumer products. You can now see why the government wants to break this company into two or three units. In many ways, Microsoft is already prepared to split into such units. The big question in the minds of current and prospective investors, is what will such a split do to the company's bottom line. Even long term fans of Microsoft have said that such a slit would reduce the intrinsic value of Microsoft stock.

First of all, let me look the value after split question. Microsoft has never been a buy because of its intrinsic value and so if its value based on parts is lower than what it would be without, it is not worth worrying. If that sum-of-parts value is significantly higher than the current stock price of $61, it is still a great deal. However, I don't agree that the split parts are likely to create less valuable parts, in the long run. Shorter term, the question is irrelevant because if you are buying a tech stock for a short term flip, you are in a camp I don't wish to join.

Why do I think, splitting the company will not reduce its value, long term? Take Windows for example, this product did not exist 15 years ago and had a very small revenue base for years after. I used the predecessor operating systems back then; products like Framework, DOS and the Apple. None of these were bad products but they all lacked a key attribute, the ability to adapt to the user quickly and efficiently. Microsoft did and they have the market. Did they come up with the most innovative product of the curing-cancer ilk, not at all. I can repeat exactly the same argument for Excel, Publisher, Word and even Internet Explorer. Did Microsoft break some laws in the process? Probably but do I care, no again. Would Oracle or Sun Microsystems or even Netscape have produced an easy to use, well supported and cheap software for me if it was not for Microsoft. I have my doubts.

The bigger question from an investment viewpoint is what is the stock going to do next. Whether the company is broken or not, as long as the developers including Bill Gates are in the business and with the company, they will be making new products at cheap prices and with mass appeal. They know how to do that and no one else in their business has figured this secret out yet. And until some one surfaces with that bent and intellect, I will bet that this company will keep getting your software dollars. And as long as that keeps happening, your investments will grow, sooner or later.

Does that mean you should go and buy the stock this morning. Don't ask me about timing, I am no technician.

CHARTS:

I am not about to classify MSFT anything  but a growth company. The full value for MSFT is 50  times its earnings, a level which will probably not reached as long as the monopoly-busters are on its case. It has always traded at that level historically, though.

The forecast EPS numbers  range from $1.67 this year to $1.87 for 2001. Using last year's actual results as the low case we should be getting to the $90 range when the pall is over. That is a 50% return for some one brave enough. 

Following inputs were used to derive the fundamental P/E;

Return on Equity   25%     Beta                1.60     Debt/Capital        0%     Plowback            100%

Last Updated May 12, 2000