Bullish, But Not on Ballmer

07/14/2011 7:30 am EST

Focus: MARKETS

Charles Carlson

Editor, DRIP Investor

Broadly, the market looks like it’s going through the natural progression of events, but some legacy stocks are showing some signs that may hamstring long-term success, notes Charles Carlson of DRIP Investor.

The stock market’s recent pullback has given rise to fears that the bull market is over. I don’t think so.

True, the latest pullback has been a bit scary, and the reasons for the pullback—possible slowdown in the economy, continued fears of a meltdown in the Eurozone, strife in the Middle East, high commodity prices—are very real.

However, when viewing market pullbacks and trying to determine whether they represent short-term market dislocations or more significant declines, keep in mind a few things:

  • Secondary corrections are part of all bull markets. Corrections purge the speculative froth that builds during bull-market runs, restore values, and provide a new springboard from which bull markets can continue. Thus, you cannot have long-lasting bull markets without them.
  • Secondary corrections typically fit a profile, and this one has been no exception. Bull-market corrections are usually violent and abrupt, but not long-lasting. Secondary corrections typically last three weeks to three months, and generally retrace one-third to two-thirds of the previous advance. Based on those parameters, the latest correction has been quite typical.

Bottom line: I would still regard the pullback as an opportunity to add quality DRIPs, rather than a time to dump stocks.

Everyone’s familiar with the phrase “too big to fail.” It gained a permanent place in the American lexicon following the financial disaster of 2008, when many of our nation’s largest banks and financial institutions were bailed out under the notion that letting them fail would have destroyed the entire financial infrastructure of the US and, quite possibly, the world.

Yes, size matters when it comes to survival. But does size matter when it comes to success? I saw a headline the other day describing the federal government as “too big to succeed.”

The essence of the story was that Uncle Sam is so big, with so many layers of bureaucracy, so many constituents to satisfy, so many agendas to clear, that it has made successful central planning virtually impossible.

The government’s “size” problem got me thinking about corporations, and whether they can get to be too big to succeed. I think the answer is yes, especially in certain industries in which dynamism, speed, and innovation are especially prized.

Like the technology sector. Tech stocks seem the most vulnerable to the “too big to succeed” label. Tech investors want the newest and shiniest, and size seems to equate with old and slow. Case in point is Microsoft (MSFT).

Here you have a technology giant that has put up revenue and earnings numbers that should appease investors. Cash flow is huge. The company is a leader in several of its markets. Yet, the stock gets little love from tech investors.

Is Microsoft too big to succeed?

A lot of the technology cognoscenti believe so. Nobody wants to work for a bloated, stodgy giant in the tech sector, so Microsoft no longer gets the best and brightest tech talent, or so critics say.

And its PC-centric business is so, well, old school. Tablets and smart phones and “the cloud” are the place to be, not some “closed” operating system that runs on machines that nobody wants anymore.

Do I buy all of that? No, but I have to admit that at some point an investor has to listen to the stock price…and Microsoft’s stock price has been saying that something is not quite right with the firm.

What can Microsoft do to shed the “too big to succeed” label? That’s easy. Get smaller.

The firm could split up into different companies, each entity focusing on a particular business segment—operating software, server software, entertainment (such as the Xboxproduct line), etc. The company could also get smaller by jettisoning slow-growth or money-losing businesses (such as Internet search).

And the firm could stay smaller by eschewing potentially shareholder-value-destroying acquisitions (such as the recent Skype deal). They could instead return funds to shareholders in the form of dividends.

Getting smaller would make Microsoft a more attractive place for tech’s best and brightest to work, create an environment in which innovation and entrepreneurial spirit would thrive, and, most importantly, allow Wall Street to value the parts more precisely—all of which would mean better returns for stockholders.

In some respects, it seems so obvious. And yet, it isn’t going to happen in the near term. Why? Steve Ballmer, the current CEO.

I can’t fathom Ballmer ever shrinking Microsoft by splitting into pieces. The fact that he is willing to buy Skype says volumes about what direction in terms of size he wants to take Microsoft—bigger.

The fact that investors are not excited about Microsoft is not entirely Ballmer’s fault. Still, when a team is underperforming, it’s usually time to fire the coach. It may not always be fair or even justified. But change is necessary some times, especially if change may bring a better direction for the firm.

Bottom line: Microsoft is too big to succeed in the way that Microsoft shareholders would like. The solution is to get smaller. But in order for that to happen, Ballmer must go.

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