A Turnaround Years in the Making

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Take Ahold of This Turnaround

This week’s hot stock has almost been written off by many market pundits. As commonly happens, media coverage tends to overreact to bad news, and those reactions can begin to drown out any positive news. This week’s company has a strong history of growing profits and — despite not being the high-flying, rapidly-growing company it once was — still offers you a great potential return on your investment. When the market talks, the best response can be to not listen. This week’s hot stock is Microsoft (MSFT)

Microsoft has grown after tax profit (NOPAT) by 8% compounded annually over the last five years. The company currently has a 55% return on invested capital (ROIC) which is beyond impressive for a company that is entering its fifth decade. As we mentioned above, Microsoft is no longer the high-growth stock it once was, but is now a company that consistently produces profits while incrementally improving its business operations. In 2014, Microsoft grew revenues by 12% over 2013 and generated $14 billion in free cash flow. While allowing for more free software, services, and monetization of add-ons will be difficult, CEO Satya Nadella is off to a great start in his turnaround efforts, and the future looks bright at Microsoft.

At the moment the market is undervaluing MSFT, and the stock earns our Attractive rating. Business shifts don’t happen overnight, but when you can catch on to one as it’s happening, it can be highly profitable for your portfolio. Many of the longest-tenured companies in the world are in a serious state of transition, some to completely different industries. Microsoft has long been shifting to become a more stable company, and as this shift accelerates, investors should give MSFT a serious look. At its current price of ~$42/share, Microsoft has a price to economic book value (PEBV) ratio of 0.9, which implies that the market expects Microsoft’s NOPAT to permanently decline by 10%.

If Microsoft can grow NOPAT by just 7% compounded annually for the next eight years, the stock is worth $67/share –– a 68% upside. Coupled that potential upside with the near 3% dividend yield and its clear why Microsoft is a great addition to anyone’s portfolio.

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

Photo Credit: Mike Mozart (Flickr)

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