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Microsoft Stock Is NOT a Bargain Right Now

Microsoft (MSFT) has long been a force to be reckoned with, and this year showed investors that even a post-PC age doesn’t mean profits have passed it by. Despite an ugly earnings report, the tech giant is still up more than 19% year-to-date in 2013 to outperform the market and boasts a 2.9% dividend yield to boot.

But don’t fall into the trap of thinking Microsoft is safe.

Yes, the company has a forward price-to-earnings ratio of around 10.5 and a staggering $77 billion in the bank. But MSFT stock is on the wane, and one way or another it will end up costing you a lot over the next few years.

Microsoft just reported Q4 earnings, including almost $20 billion in revenue and just shy of $5 billion in net income. Not bad, right?

Well, unfortunately, Microsoft posted $6.06 billion in income last quarter. So, that’s actually very bad.

The reasons are myriad, but a big driver in the decline comes to a $900 million charge related to Surface inventory adjustments. Ouch!

This is bad not just because of the hit on the bottom line, but because it’s indicative of a false-start in the mobile space that Microsoft so desperately needs to figure out.

Consider that the last 15 years have been nothing but a downward spiral in licenses, margins and brand power for the enterprise giant. Yes, the Apple (AAPL) suite of devices including the iPhone and iPad were the first threats to the MSFT empire. But now Google (GOOG) and its ubiquitous Android seems to be perhaps even more of a threat, because that’s open source and has allowed the expansion of Amazon (AMZN) into hardware via its Kindle as well as other dedicated hardware stocks like Samsung (SSNLF).

Look at this chart, courtesy of Business Insider. Internet connected devices have soared since 2005 … but Microsoft has failed to participate in that boom with its flagship Windows operating system or with its mobile Windows Phone offering. Windows may have a stranglehold on PCs, but PCs are not the way of the future.

computing market share

Most Microsoft investors talk about the Windows “monopoly” and the wide moat in the PC space that MSFT has. That’s true, and it isn’t going anywhere. But note that a competitor hasn’t had to erode the Windows empire (and related businesses like Office software, of course) so much as render it meaningless. Google and Apple could care less about it, and that says everything you need to know.

After all, Henry Ford didn’t need to figure out how to build a better horse to put related businesses on their heels … he simply needed to figure out a viable alternative and go about building an empire as the livery and saddle shops collapsed from within.

I remain convinced that laptops and desktops will play a role in the future of computing, especially in enterprise settings. However it is unlikely that simply fending off complete obsolescence will be enough to result in growth at Microsoft — especially if its Surface line continues to meet with headwinds.

Microsoft has a host of headlines across the last several months that make good excuses — its CFO stepped down, the Xbox One is rolling out even as the division leader jumped ship for embattled video gaming stock Zynga (ZNGA), the threat of activist shareholders shaking things up, and so on.

But the Surface and mobile troubles, coupled with the secular decline of the PC, cannot and should not be overlooked.

Down the road there’s a good chance that Microsoft will gain traction in mobile. After Apple and Google, its only real competition is BlackBerry (BBRY) — which has a lot of trouble of its own, but more importantly doesn’t have even close to the balance sheet that MSFT does. Microsoft can afford to throw billions at mobile until BlackBerry dies and some of that enterprise business migrates over.

But if that’s your best hope — and I think it is, for Microsoft — then you have to be realistic about what Microsoft shares will do. The dividend yield is nice, yet, but I don’t think the selloff was an overreaction after the sharp run-up in shares.

The bottom line is that Microsoft is a company with an uncertain future and earnings are pretty lackluster. That doesn’t warrant the outperformance we’ve seen year-to-date and will eventually get priced into shares further over the months and years ahead.

And if you really want a troublesome outlook for tech? Consider that this kind of pressure is likely to increasingly become a part of the conversation about Hewlett-Packard (HPQ), Dell (DELL), Intel (INTC) and other PC-reliant businesses in the future.

Yes, they all have plans to get beyond PC demand and into mobile … but as Microsoft earnings showed, simply trying is not enough to satisfy shareholders forever.

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Jeff Reeves is the editor of and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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