Microsoft reported third quarter earnings of $2.98 billion, or 29 cents per share, on revenue of $10.9 billion. Revenues were up 13% and earnings were up 16%...but the stock is down about 5%. The stock market is all about expectations and momentum. Microsoft didn't meet expectations and has lost momentum due to product delays and organizational changes. Robert Scoble is biting his tongue...not sure what is appropriate to say. We all feel good about the company and products, but are disappointed in the financial results and stock price.
DISCLAIMER - This is my personal blog and these are my personal views. They do not reflect the views of my employer, Microsoft.
Microsoft is no longer considered a "growth" stock by the stock market, and hasn't been for 5 years or more. Growth stocks don't pay dividends, they grow revenues and earnings by 20% to 50%, and are rewarded by the stock market with P/E ratios of 30 to 50.
Microsoft is a more like a "blue chip" stock but isn't paying the higher dividends normally associated with blue chips. It is a natural progression for successful companies to go from growth stock to blue chip stock, and the market rewards companies that adapt to the changes.
In my view Microsoft has three choices;
- Continue as is, consistent profits but small dividends, and the stock will probably continue to flat line.
- Increase dividend payouts and become a blue chip stock. The stock price would probably jump immediately and then increase slowly over time.
- Split the company up into two stocks; a growth stock for MSN, Xbox, Search, and other growth segments, and a separate high dividend stock for the core client and server based products. The stock market would probably reward each stock with appropriate values and multiples.
Microsoft is firmly stuck in the middle. The dividend has increased slightly over the years, but not enough to be truly interesting. Microsoft has grown top line revenues by about $4B a year for several years. That is HUGE growth, but against a base of $35 to $40B it is only about 10%...not enough to be considered a growth stock by the market.
Microsoft is incredibly profitable and generates huge, predictable cash flow. Microsoft consistently grows about 10% even without shipping any new products. Microsoft has $34B in cash and adds about a billion per month to the pile. The stock price problem is all about growth (the law of large numbers), and expectations. Here is what the company said about future expectations;
Microsoft management offers the following guidance for the quarter ending June 30, 2006:
Revenue is expected to be in the range of $11.5 billion to $11.7 billion.
Operating income is expected to be in the range of $4.0 billion to $4.2 billion.
Diluted earnings per share are expected to be $0.30.
Management offers the following preliminary guidance for the full fiscal year ending June 30, 2007:
Revenue is expected to be in the range of $49.5 billion to $50.5 billion.
Operating income is expected to be in the range of $18.7 billion to $19.3 billion.
Diluted earnings per share are expected to be in the range of $1.36 to $1.41.
The stock market analysts are worried about the soft profit projections for next year and the significant increases in spending. The company didn't mention where the spending was going, but Ray Ozzie gave some clues in his recent CNN interview. Think huge server farms and infrastructure for Windows Live, Office Live, and LiveDrive.
These investments will take time to return a profit, just like the Xbox investments which will be profitable some day. Investors are very impatient and have lots of investment options for their money. They are choosing other options today, but they will be back when the growth returns.
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