Toys, Tech Turn in Microsoft's Favor

12/06/2010 12:37 pm EST

Focus: STOCKS

Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

Taesik Yoon, editor of Forbes Growth Investor, believes shares of the software giant could roar if products like the motion-sensing game controllers deliver on their early promise.

Microsoft (Nasdaq: MSFT) is the world’s largest provider of software and related services.

Fiscal first-quarter results proved better than expected, aided by strong demand for the Office 2010 and Xbox 360 products, and continual adoption of the Windows 7 operating system. Total revenue climbed 25% from the prior year to $16.2 billion while net income jumped 51% to $5.4 billion, or 60 cents per share. This was 7 cents ahead of the consensus estimate.

Even excluding the impact of $1.47 billion in deferred revenue in the prior year, revenue and earnings per share grew 13% and 19%, respectively.

Yet this impressive growth has done little for the stock, which trades at an attractive 10.9 times the consensus earnings estimate for fiscal 2011 of $2.47 per share. [Shares had been down more than 7% since Nov. 2 before retracing the bulk of those losses over the last three sessions—Editor.]

The company also sports an insanely strong balance sheet with $44 billion in cash and just $10.7 billion in debt. [Not to mention the 2.5% forward annual dividend yield—Editor.]

Microsoft, the Kinect Animal

In its report, Microsoft noted that bookings were up 24%. Bookings in the past three quarters were also the highest over the past three years. This suggests operations over the next several quarters should remain strong.

Near-term results should additionally benefit from the launch of several key products from the Entertainment and Devices segment. This includes the Window Phone 7 mobile operating system, which debuted on numerous smart phones carried by multiple wireless network carriers last month. It also includes the promising and much-hyped Kinect peripheral for the Xbox 360, which we believe will be among the hottest gifts this holiday season. Microsoft has already raised its forecast for sales of the motion-controlled device for the current quarter by 67% to 5 million units.

Over the longer term, Microsoft expects spending on enterprise information technology to continue growing for the rest of fiscal 2011, benefiting from the ongoing business PC refresh cycle. [As companies replace their old machines with new ones—Editor.] This should help keep sales of the Windows 7 operating system and Office business software products robust.

[Microsoft’s not the only cheap tech stock around: Two weeks ago, Michael Murphy noted that the entire sector has fallen out of fashion despite its rapidly growing earnings and sales. James Stack recently singled out Mr. Softee as an unjustly “forgotten giant,” along with Intel (Nasdaq: INTC)—Editor.]

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