Software giant Microsoft (Nasdaq:MSFT) has hit another one of those pockets where there is just not much going on to excite investors. The next iteration of Windows 8 won't come out for months, the company is annualizing the Office 2010 launch, the PC market is soft, and a lot of the company's enterprise products are still building up some momentum. So while this stock looks quite cheap on its cash flow generation potential, value-oriented investors interested in this name have to bring ample patience with them as well.

Investopedia Markets: Explore the best one-stop source for financial news, quotes, and insights.

A Ho-Hum First Quarter
Microsoft reported overall revenue growth of 7%, which is not so bad in the broader context of mega-cap tech names like IBM (NYSE:IBM) or Oracle (Nasdaq:ORCL). Revenue from Windows was up just 2% as sluggish domestic PC growth hurt sales and rampant software piracy in regions with high PC growth sapped sales. The server and tools segment showed a nice 10% increase in sales, while the business unit was up almost 8% and entertainment was up more than 9%.

Where Microsoft did not do so well was in margins. Gross margins slid more than two points from last year and operating income growth was just 1%. Some of this margin erosion can be tied to higher royalties in the Xbox business, while the online partnership with Yahoo! (Nasdaq:YHOO) is also having a negative effect. Last and not least, the Skype deal is bringing lower margins with it and incremental integration expenses.

When Will Mobile Ventures Pay Off?
One of the big worries around Microsoft is that Google (Nasdaq:GOOG) and Apple (Nasdaq:AAPL) have already elbowed them out of the growing mobile device market. To be sure, Microsoft was caught unawares here and is clearly behind today. On the other hand, this market is still younger than many investors seem to realize and Microsoft is not exactly helpless.

The question, though, is whether Microsoft's initial moves are the right ones. In some respects, Microsoft's deal with Nokia (NYSE:NOK) is like the opposite of Google's deal with Motorola Mobility (NYSE:MMI). Motorola has at least had some successful smartphone launches in recent memory and the buyout gives Google access to patents. Microsoft, though, is not acquiring that IP and instead has to hope that Nokia management can rebuild the company into a contender.

Skype is likewise a tricky deal to assess today. Skype certainly has potential, but eBay (Nasdaq:EBAY) and other prior owners were not able to deliver or realize that potential. In theory, pairing Skype with third-party licensors could be very powerful for Microsoft, but this will take years to build.

Microsoft Should Consider a Bigger Enterprise Push
Conventional wisdom on Microsoft seems to understate the extent to which Microsoft already plays in the enterprise IT space. Even allowing that the business division sells plenty of product to "civilians," this is a sizable enterprise IT business. That is not to say that sizable cannot become bigger. Microsoft would likely have little interest in acquiring VMware (NYSE:VMW) or Red Hat (NYSE:RHT), but that does not mean that Microsoft cannot take a page out of the IBM-Oracle book and make a few selective growth-additive deals. After all, it's not like Microsoft gets much of a multiple as is or much credit for returning that cash to shareholders.

The Bottom Line
Microsoft hardly inspires pity or sympathy, but this is not a company that I would like to run. It is almost impossible to keep focus on an innovative culture across such a large business - especially when it has such large legacy-support needs. With that size and scale, it's hard to be innovative and hard for innovations to really stand out and get much attention.

Microsoft needs to decide on some new dynamic directions for the business (like the aforementioned enterprise-focused acquisitions) and then sell the Street on that direction. If they don't or can't, this stock is likely to stay a value for some time to come. Investors can certainly buy into this undervalued cash flow stream, but they need to have a proper perspective - however inadequate the multiple may be, the Street feels like it has this one figured out and a significant realization of that underlying value is likely to come only from shaking up those perceptions. (For additional reading, see A Primer On Investing In The Tech Industry.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!