Sunday, May 29, 2011

Microsoft - Why it's Cheap.

You gotta love articles like this one I found on Reuters:

Hedge fund manager David Einhorn on May 25 called for Microsoft Chief Executive Steve Ballmer to step down, saying the world's largest software company's leader is stuck in the past.

"His continued presence is the biggest overhang on Microsoft's stock," said Einhorn, who founded Greenlight Capital.

Ballmer took over as CEO in 2000 from Bill Gates, who remains chairman.

Microsoft stock is down 30 percent over the past decade, and up 4 percent over five years. On a total return basis, including dividends, shareholders have lost 12 percent over 10 years and gained 14 percent over five, according to Thomson Reuters Datastream.

Including dividends, investors have lost 26 percent on Cisco Systems over a decade and are down 20 percent over five years. For General Electric, total returns have been minus 47 percent over 10 years and minus 32 percent over five

This is the problem with the media and many investors in general.  While all of the numbers are true, it doesn't paint an accurate picture of the performance of these companies.  These companies were so severely overvalued ten years ago this is hardly a fair comparison... they were price for perfection.  Now, nobody will touch them.

I am nearly finished reading the book Against The Gods by Peter Bernstein.  It is a classic financial piece about the history of risk and the mathematics of probabilities.   In chapter 10, when discussion the regression to the mean, the author says,

"The impressive evidence of regression to the mean might provide some valuable advice to investors who are constantly switching managers.  It suggests that the wisest strategy is to dismiss the manage with the best recent track record and to transfer one's assets to the manager who has been doing the worst; this strategy is no different from selling stocks that have risen furthest and buying stocks that have fallen furthest... Go ahead and follow your natural instincts."

Let me be clear, the past 10 year performance of General Electric (GE), Microsoft (MSFT) and Cisco Systems (CSCO) are the biggest overhang on these stocks and I believe David Einhorn knows that.  He's just looking at a way to shake things up, get the stock out of the rut and get the market to look deeper at the value of Microsoft.  

If you want to make money investing here is what you should do.  First, take the stock price and stock chart an toss them in the garbage.  Second, read a couple past annual reports to understand the company.  Third, examine the 10 year past financial operating performance of the company.  Fourth, determine what you would be willing to pay for the entire company.  Fifth, divide what you'd be willing to pay in half.  Sixth, check with the stock market to see if someone wants to make a deal on a part (share) of the company.  Repeat as necessary.

Do not, and I repeat, do not look at what has performed well over the past decade and extrapolate into the future. It will tell you to buy Gold, Silver, and commodities instead of General Electric, Microsoft, and Cisco Systems. 

Let me tell you how the vast majority of people select their stocks.  First, look at the immediate past and find what is the hot sector (or pick up a business newspaper).  Second, check out stock charts that are up strongly and preferable going parabolic.  Third, and only if you have time, check out the past ten year operating performance of the company.  Fourth, and only if you have lots of spare time and like to read, read the last few annual reports from the company.  If you only make it to step two make sure you at least justify it in your mind as a relative bargain (based on some unrealistic growth assumptions). 

Best Regards,
Kevin Graham

Disclosure:  Long GE, MSFT, and CSCO (Personally or in accounts I manage). 

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