Once the most popular software stock on the planet,

Microsoft

(MSFT) - Get Report

was largely cast aside last year by investors looking for sexier names with more room to rebound. The Redmond, Wash.-based laggard gained only about 7% in 2003 on a split-adjusted basis, trailing far behind the 50% jump in the tech-heavy

Nasdaq Composite

and Goldman Sachs Software Index.

But investors who last year flocked to tech stocks that were battered and bruised may very well shift their focus in 2004 to names like Microsoft, which offers more stable cash flow, more modest valuations, and dividends.

"After a year of underperformance, the stock seems poised to outperform in 2004," SG Cowen analyst Drew Brosseau wrote Monday in a note upgrading Microsoft to strong buy from outperform. Among several tech names upgraded by Cowen Monday, Microsoft was the only software maker. (The firm hasn't done any banking with Microsoft.)

While somewhat lost in the year-end excitement about soaring tech stocks, there's already been a hint of rotation back to Microsoft. Shares have gained nearly 8% since the end of October, while the tech sector component of the

S&P 500

is up about 7% and the Nasdaq 100 is up more than 5%. Brosseau and others say there are myriad reasons why Mister Softee is positioned to extend the outperformance as this year unfolds.

Changing tastes of investors: Slowing performance among 2003's big tech winners combined with rising interest rates that fan concerns about weak balance sheets will drive this shift, argued David Sowerby, a portfolio manager at Loomis Sayles & Co. in Detroit, which owns Microsoft shares. "In the technology space, there is some better legitimacy to Microsoft in 2004," he said.

Valuation: With a price-to-earnings ratio of 23 times calendar 2004 earnings and 21 times calendar 2005 earnings, Microsoft is trading at the low end of its historical range, Brosseau noted. Microsoft is also trading at a sizable discount to its peers, whose P/E's average 33 times 2004 earnings and 27 times 2005 earnings. "It's unlikely that Microsoft's multiple will contract much from here," Brosseau said. Notably, that relatively low multiple comes despite Microsoft's stronger fundamentals compared to most other leading software vendors, including some such as Siebel Systems , which continue to suffer year-over-year sales declines.

Stronger IT spending, particularly on Microsoft products, and personal computers bundled with Microsoft software: A survey by SG Cowen in December found that PC replacement levels are edging up for the first time in years.

Product releases, including recent releases of server and desktop products Windows Server 2003, Office 2003 and Exchange 2003.

Victim of Past Success

On one level, Microsoft has suffered for being a top performer in previous years -- and being perceived as a mature, slower-growth company as its sales have climbed so high that posting growth is even more difficult (a.k.a. "the law of large numbers"). Some investors also abandoned the stock because of various company-specific problems, including security woes, a European Commission antitrust investigation, Linux competition and declining unearned revenue.

Still, Microsoft generates $1 billion in cash a month and its earnings and revenue are expected to grow between 8% and 9% in the next couple of years, according to consensus estimates gathered by Thomson First Call. With the conclusion of the nearly three-year investigation in Europe expected this year, Microsoft is widely expected to tap its massive $50 billion cash horde to raise its now-paltry dividend.

For some, Microsoft's valuation makes owning the stock a no-brainer. The market is pricing Microsoft like a 4% bond, given the company's approximately $305 billion market cap and $12 billion in cash generated each year, said Transamerica Funds portfolio manager Chris Bonavico, who is long Microsoft. But Bonavico believes Microsoft is still a growth company, whose sales will continue to climb as a result of new Internet features in the recent release of Office and future version of the Windows operating system.

Bonavico acknowledged that some corporate customers may hold off renewing software subscriptions because truly game-changing features are still a few years off. But "the risk reward at this price is in your favor," he argued.

On Tuesday, Microsoft shares rose 10 cents, or 0.4%, to $28.24.

Despite lagging stock-price performance, Microsoft is growing as fast, if not faster, than its peers, Brosseau noted. Between 1998 and 2003, Microsoft's revenue grew an average 14%, higher than its large-cap software peers in every year but 2000, according to the analyst. Even Microsoft's 10% revenue gain in calendar year 2003 -- against a tough comparison -- still outpaced its peer group average and all but three of the top 12 software companies followed by Brosseau.

Brosseau is expecting Microsoft's earnings to climb 10% to 15% in 2004 to 2005, in line or better than most leading tech players.

Meanwhile, Microsoft's fans contend that bearish arguments about Linux competition and the unexpected precipitous drop in unearned revenue in the past quarter are overblown. Currently, Linux is

primarily gaining share from Unix -- not Microsoft. And declines in unearned revenue should become more modest while being overshadowed by growth in nonsubscription sales, Brosseau said.

Finally, there's the possibility that sexy may go out of style this year and safer bets fall into favor again. "I don't know what the market is going to do

but if it starts to falter again, people are going to migrate to this name," said a Philadelphia money manager who recently bought Microsoft shares. The source requested anonymity.

In sum, 2004 is shaping up as the year Microsoft once again is the most popular software name around.