Sunday, November 04, 2007

Microsoft Analysis

Microsoft released its quarterly report recently which beat the analyst estimates. It caused the stock to pop - we look in this section to see if Microsoft has further upside for the next couple of years.

Microsoft is expected to earn 1.81$/share in FY08 and $2.06 in FY09. The uncertainty with the EU has declined significantly after the recent deal. At a low end, Microsoft can trade at $36 - $41.2. At the high end Microsoft can fetch between $40 - $50 at the high end in the next two years.

Let us analyze each of Microsoft's businesses by segment in the latest quarter as reported.

Client: 80 cents of income for $1 of revenue.
Server: 33 cents of income for $1 of revenue.
Online: -39 cents of income for $1 of revenue.
Microsoft Business Division: 65 cents of income from $1 of revenue.
Entertainment and Devices: 8.5 cents of income from $1 of revenue.
Separately, -7.3 cents per dollar is spent on corporate level activity.

This table shows the usefulness of various Microsoft divisions. Windows client is by far the most profitable group followed by Microsoft Business Division. This is followed by Server and Tools. Entertainment and Devices and Online are losing money/marginally profitable as is corporate level activity.

Microsoft's strength is its windows (client,server) and office franchises. These businesses should continue to drive Microsoft for the next five-ten years. As the spending in corporate level activity shows, there is room for improvement in capital allocation. One can also expect stock buy backs to offset further stock dilution. On a positive note, the company is returning capital to the investors in the form of dividends which will allow the shareholders to deploy it in a more meaningful fashion.

However, for the next two years, the downturn in housing and financial sectors would continue to propel technology stocks. This should help Microsoft attain further peaks in its stock price.

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