Microsoft Investors' Patience About to Pay Off

BOSTON (TheStreet) -- Despite ranking among the cheapest Dow components, generously buying back shares, boosting its dividend an annualized 12% since 2006 and increasing net income 27% during the past four quarters, Microsoft (MSFT) suffers from perennial stock price stagnation. Bargain-hunters, ranging from individual investors to hedge funds, have barely been rewarded for holding the equity, which has fallen 5.9% in five years.

The thesis was, and continues to be, that Microsoft has dominant market share in the software industry, producing such lynchpin programs as Office, Internet Explorer and, of course, operating system Windows, and that its stock is cheap when considering both historical multiples and peer investments. For example, Microsoft's stock trades at a trailing earnings multiple of 11, 33% less than its five-year average. And, it sells for an enterprise-value-to-EBITDA multiple of 6.2 and a free-cash-flow multiple of 9.5, equal to 70% and 72% software-industry discounts. In addition, Microsoft's operating margin, at 40%, ranks in the 97th percentile for its industry. So why won't its stock pop?

The obvious answer: Value and fundamentals are no guarantee of performance. Stock prices, despite any claims to the contrary, ultimately are a function of supply and demand. With a market value of $214 billion, third-highest in the mega-cap Dow, Microsoft suffers from an oversupply of shares, and demand simply can't keep up. However, that doesn't mean the stock is doomed. Provided that the company is able to maintain its competitive position and reward shareholders through buybacks and distribution increases, investors are "paid to wait" for the stock to reflect fair value. For those who reinvest dividends, the wait will be worth it.

Microsoft is scheduled to report fiscal third-quarter results tomorrow and Wall Street expects adjusted earnings to have grown 24% year-over-year to 56 cents a share and sales to have grown 12%, past $16 billion. Microsoft continues to offer outstanding metrics, including a return on equity, the most important profitability measure for shareholders, of 42% in the latest quarter, twice the industry average and three times the S&P 500 average. Return on assets, indicating the overall profitability of Microsoft's asset base, at 22%, reflects superb efficiency. Analysts' view of Microsoft remains overwhelmingly positive, with 73% rating its stock "buy."

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