Scoop Up Microsoft on the Pullback

 | Jul 22, 2013 | 9:00 AM EDT  | Comments
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Microsoft (MSFT) was the very worst performer in the S&P 500 Index last week, with a 12% drop in the shares. Almost all the damage came Friday, when management said its Surface tablets weren't selling well and that the company would take a $900 million write-off on that business.

If you don't already own this name, I think the drop presents a good opportunity to add it to your portfolio.

Of course, you have to consider how many information-technology stocks you've already got. If you are underweight tech, I think Microsoft deserves consideration -- and if you have a tech stock you want to sell, I think Microsoft would make a good replacement.

I'm not trying to minimize this company's failure to penetrate the tablet market. But even Ted Williams struck out once in a while. Microsoft has multiple product lines, and many strengths. For instance, Windows and Microsoft Office (featuring Microsoft Word, Excel and PowerPoint) are mature products, yet they're still selling in mass quantities. The Xbox video game system is doing well, too. The Skype messaging service, bought in 2011, is popular.

There's a popular perception that Microsoft's glory days are behind it -- and, in one sense, that is true. Microsoft shares climbed 1,177% from the end of 1994 through the end of 1999, surely one of the greatest five-year advances on record. The stock won't do that again, and hardly any other stock will, either.

But there's still a lot of power in the company -- and, in my opinion, the stock still has room for handsome gains.

In its 27 years as a public company, Microsoft has reported a profit 27 times. In 23 of those instances, the profit was higher vs. the year before. In addition, Microsoft held up well in the recent hideous recession, as compared with many companies: In fiscal 2009 (ended June 2009), the company's earnings fell 17%, to $14.6 billion from $17.7 billion.

People talk all the time about Apple's (AAPL) cash hoard. Apple has $39 billion in cash and short-term investments. Microsoft has $77 billion.

Microsoft shares are also reasonably valued at 12x earnings, and the dividend yield is nearly 3%.

Finally, and to my mind most tellingly, Microsoft still boasts phenomenal profitability. The pretax profit margin last year was more than 35%, and the company earned a 33% return on stockholders' equity. These are the signs of a robust franchise, not an aging one.

John Dorfman is chairman of Thunderstorm Capital LLC, a money-management firm in Boston. He can be reached via email here.

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