Question: Will Microsoft catch up to Apple and Google?

Bull's Response
A lot has happened since Microsoft (Nasdaq:MSFT) announced mediocre first quarter earnings October 18. Earnings per share were 53 cents, compared to the analyst consensus estimate of 57 cents, while revenues declined $1.4 billion to $16 billion year-over-year. Its Windows division took the biggest hit, generating $3.2 billion in revenue, 33% less than in last year's first quarter. Worldwide PC shipments in the third quarter on a calendar-year basis (MSFTs Q1) declined 8.6% year-over-year, suggesting that things are going to get worse for Microsoft before they get better. That might be true, but there are several reasons why a bet on the tech giant isn't a bad idea. I'm bullish about Microsoft. Here are some of the reasons why.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Windows 8
In a November 3 article in TechCrunch, Tadhg Kelly observes that Microsoft sold 4 million copies of Windows 8 in the first few days available. With something like 670 million Windows 7 licenses out there, it's a certainty that Microsoft is going to sell many more copies in the days and weeks to come, regardless of how good or bad you feel the operating system is.

If you consider that it sold those 670 million copies in just three years, how many do you think it will sell with a product Gizmodo reviewer Kyle Wagner calls "... the New Deal, for PCs." Suddenly Windows is relevant again, because you're going to have to re-learn how to use it for the first time since 1992.

However, Microsoft has made it possible for Windows 7 users to see their desktops exactly the way they were if they choose to, while still running Windows 8. That's going to convince many people to shell out the $40 to update. Ultimately, Microsoft's merging of its tablet and PC operating systems will allow most Windows-based computers to be touch-friendly - the real upside in a computer world that's moving in this direction.

Surface RT Tablet
Microsoft launched its Surface RT tablet on October 25 to mixed reviews. The negative comments seem centered on battery life and limited availability of software and applications. These things can and will be fixed in due course. The Windows online store might appear barren at this point, but you can be sure that developers are working quickly to build new applications and software geared to Windows 8. Steve Ballmer says that, despite Surface only being available at the online store, 34 pop-up stores it has opened for the holidays and 30 existing Microsoft retail stores, the reception for its tablet has been fantastic.

Once Microsoft widens distribution, expect the tablet sales to really start cooking. Consumers now have three operating systems to choose from when it comes to buying a tablet. According to DisplayMate Technologies, a respected tester of electronic devises, it gives the Surface RT's display an A-minus, which compares favorably with Samsung's Galaxy Tab 10.1 (B+) and only slightly worse than the iPad 3, which got an A.

Once Microsoft is able to demonstrate that its RT version of Microsoft 8, which is intended for ARM-based devises like tablets, is a reasonable operating system, manufacturers will be off to the races. Some worry that Microsoft's entry into the PC game might discourage some of its partners, but like Google's (Nasdaq:GOOG) Nexus 7, it will stimulate interest rather than detract from it.

SEE: A Primer On Investing In The Tech Industry

Eighteen months ago, Microsoft paid $8.5 billion for Skype. Investors wondered at the time what it could do with the Internet phone service that eBay (Nasdaq:EBAY) failed to capitalize on. Well, Microsoft announced November 8 that it was ditching its Windows Live Messenger (WLM) instant messenger tool in favor of Skype's, which will enable all WLM users to also video call their messenger contacts.

Adding 100 million WLM users to Skype's 280 million users should make it a formidable opponent in the instant messaging game. Commercial uses for this integration seem only natural, but time will tell if Microsoft can keep this ball moving forward. More importantly, a Skype app will be available for both Windows 8 and Windows RT users, which should help Microsoft's mobile phone business.

Financial Situation
There are plenty of arguments why you might not want to own Microsoft's stock including the fact the company appears to be extremely dysfunctional. The firing or resignation of former Windows boss Steven Sinofsky indicates there was a wide chasm between Sinofsky and the people he worked with on a daily basis. Once Windows 8 was out the door, it was a perfect opportunity for a change.

It's going to take at least a year before anyone can safely label the new operating system a success or failure. In the meantime, despite falling revenues, its free cash flow as a percentage of both revenue and net income is higher than it's ever been. It could spin-off its $66.6 billion in cash into a separate company operating much like Berkshire Hathaway (NYSE:BRK-B) and still function properly. Like Berkshire Hathaway, its cash hoard is a blessing and a curse.

SEE: 5 Must-Have Metrics For Value Investors

The Bottom Line
Microsoft's traded in a narrow $20 range the last 12 years. My case for being a bull rests largely on the fact that it has a better chance of going to $60 in the next few years than it does dropping below $20. If the combination of the Surface tablet and Windows RT can be even remotely successful, things could get a whole lot brighter in Seattle.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

Don't forget to read the Bear side of this debate and weigh in with your opinion below.

Related Articles
  1. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  2. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  3. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  4. Investing

    Has Apple Finally Hit the Wall With the iPhone?

    We look at how the iPhone has sold over its brief existence and what that means for the future of the smartphone market.
  5. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  6. Investing

    The Top Businesses Nurtured By Y Combinator

    We look at the top startups that were incubated at Y Combinator, one of the world's most popular business incubator firms.
  7. Investing

    Is It Time To Bet On The iPad Again?

    Apple's focus on iPad has been fairly tepid these past few years. But, the iPad Pro was the centerpiece of the company's latest product announcements. Why?
  8. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  9. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  10. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. 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 >>

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!