We reiterate our pick for last week’s Stock Pick of the Week: Buy Microsoft Corp (MSFT) — Very Attractive Rating. We consider the recent downgrade from Goldman an investment-banking driven head fake. Because MSFT is not a good investment banking client (very little merger or stock offering activity), investment banks have little to lose by downgrading or putting a sell rating on the this stock.
As detailed in that post, MSFT offers a Very Attractive Risk/Reward as the current valuation implies MSFT’s profits will permanently decline by over 20%. The Goldman research reports makes no mention of the already low expectations in the stock price. In fact, I think the analyst is oblivious to how cheap the stock is as part of her reasoning is an “elongated” time frame for revenue growth from the refresh in the PC purchasing cycle. A delay in revenue growth is not nearly as bad as a (permanent) 20% drop in profits.
MSFT (click here for free report) remains one of the most profitable companies in the world with an ROIC over 60%. Over 90% of world’s computers rely on them. A 20% drop in profits is unlikely and, certainly, not likely to be permanent. In many ways, MSFT is to the software business like McDonald’s is to the fast food business. MSFT does not need to lead the cutting edge of innovation of new products. It can wait for other players to spend the R&D to invent and establish new products. Then, once they know the new product will be profitable, they can add it to their huge distribution platform a a much lower cost than what the innovators spent to invent.
The Goldman downgrade presents an opportunity to buy MSFT at a slightly cheaper price than when we made it our Stock Pick of the Week last Tuesday.