MSFT: Pape's Pick

05/19/2006 12:00 am EST

Focus:

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Few stocks are as loved and hated by the advisory community as Microsoft, and in recent years "hated" has been the more operative word. One fan, however, is Gordon Pape, who assesses the latest earnings report and reaffirms a bullish outlook.

"Microsoft (MSFT NASDAQ) was recently hammered after the company released third-quarter results for fiscal 2006 that came in below estimates and accompanied that blow with some discouraging guidance. The share price fell $3.10 on April 28 after the results came out the previous evening. Microsoft will never again be the fast-growth goliath of the 1990s but it remains one of the cornerstone companies of the information technology industry. I continue to see it as a long-term core position for any investor who wants exposure to that sector.

"The recent drop was the biggest one-day loss since the tech crash began in 2000. The influential brokerage firm of Morgan Stanley contributed to the selling frenzy by downgrading the stock after the results were released. On the surface, the financials didn’t look all that bad. Revenue for the quarter ending March 31 came in at $10.9 billion, a 13% increase over the same period last year. Operating income was $3.89 billion, a 17% increase from the prior-year period. Net income was $2.98 billion (29c per diluted share), up from $2.56 billion (23c a share) a year ago.

"However, analysts had been looking for $0.33 a share for the quarter so alarm bells immediately sounded. They got louder when the pundits looked closely at the guidance for the rest of fiscal 2006 and preliminary estimates for fiscal 2007. Revenue for the fourth quarter of the current fiscal year is projected to be in the range of $11.5 to $11.7 billion with diluted earnings per share forecast at $0.30. That’s well below the previous analysts’ consensus of $0.34 a share.

"For fiscal 2007, the company forecasts revenue to be in the range of $49.5 to $50.5 billion with operating income in the range of $18.7 to $19.3 billion and diluted earnings per share of $1.36 to $1.41. Again, there was no joy for analysts in these numbers. The previous 2007 consensus had been for earnings of $1.53 a share. Predictably, the stock was punished, perhaps too much so.

"We originally recommended Microsoft in January 2003, at just above current price levels. But we should not lose sight of the fact that since my original recommendation we have received dividends totalling $3.72 a share so we are showing an overall gain on this stock. We continue to rate the shares a buy and believe the price drop offers a good entry opportunity."

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