Recently I was given two very enthusiastic tips on a giant technology stock. One from a guy who was practically born into the industry. The other from a shrewd investor I’ve known for years. A bean counter extraordinaire.
One said buy, the other said sell. I didn’t know what to do. I procrastinated and ended up missing out. In a few short weeks the stock’s up 10%.
But I should have known better. Today I want to explain why. I’ll explain why I was guilty of a mistake that investors constantly make – falling for anecdotes.
And I’ll explain why we could still see a 40% upside on this stock.
Two guys in the ‘know’
It was my brother who was first to offer his thoughts on this giant tech group. Kirit has been in the technology industry since he was a nipper. He’s at the cutting edge of this businesses, he knows what’s what in this game. He’s the computer nerd.
The other came from a contrarian investor I’ve known for some time. This is a guy who’s totally committed to doing all his own research. And he’s absolutely focused on stocks where he sees deep embedded value. He’s the bean counter.
I trust both their judgement implicitly. And when they’ve got an investment idea I’ll listen. But they can’t both be right!
My brother’s tip: Sell Microsoft. Their monopoly on Windows and Office is looking shaky. Open source platforms (which are shared and free) are becoming a serious threat. In the Far East, where he’s based, he’s seeing droves of users migrating to cheaper and better products. On top of that, Apple’s products are giving cause for concern.
Microsoft is like a lumbering dinosaur. Its monopoly has had a great run but it’s coming to an end. It was a convincing argument.
But then I read the latest missive from the contrarian investor: Buy Microsoft.
“Microsoft’s monopoly on Windows and Office is strong. They’ve got ‘customer captivity’. Businesses have built great technological infrastructure on top of Microsoft’s technology. They won’t change that just to save a few quid.”
“And then there are the people that use the systems day-to-day. For most of us it’s bad enough having to learn the technology in the first place. Do we really want to learn a load of new software packages now?”
For better or for worse (for cheaper, or for dearer) you’re ‘captivated’ by Microsoft, he argued.
And I have to admit, I was confused. Both arguments were good. Like a rabbit caught in the headlamps, I did nothing. Neither a buy nor a sell order crossed my lips. And then I saw Microsoft’s first-quarter results out on Thursday last week. Now I know which way to go
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Figures out last week took everyone by surprise (except my contrarian friend I suspect). They show first-quarter profits up 50% on revenue up 25%. That’s quite something for a lumbering dinosaur! And I have to agree with the Buy recommendation: it’s way too early to bet against its extinction.
Microsoft converted $16bn in revenue into $5.5bn of profit. And that’s the net figure. Many businesses aim to gross that margin!
Anecdotal evidence can be misleading. In this case, you observe open-source software competing in Microsoft’s key markets. You see i-pads and other mobile devices all over the place.
But then you look at the facts. The whole of the technology market is growing at pace. Microsoft tells us that the PC market grew by 10% and they grew sales even quicker. The anecdote doesn’t fit with the facts.
There could still be a 40% upside from here
Where did I go wrong? Well I fell for a story. The fact is that it is easy to make investment decisions off the back of anecdotal evidence. But if the anecdote doesn’t show up in the trading figures, then it can’t be trusted.
I suspect that’s why the shares have become cheap – and offer an opportunity.
My brother’s right, there will come a time when Microsoft comes unstuck. I’ll be looking out for that day – and keeping a close eye on their sales figures. But it would be a very brave man that would bet against Microsoft now.
But for now I think there is a very nice opportunity in Microsoft. As our contrarian investor point outs Microsoft was 29% undervalued even if you didn’t credit the business with any growth. And last week’s results show that’s clearly not the case here.
He reckons, and I have to agree, that Microsoft is likely to grow by 17% p.a – which is double the market average.
Microsoft has simply become too cheap. Its PE has headed down towards 11x earnings. The shares should revert to its former PE of 18x. That leaves an upside of over 40%, even after its recent run.
My recommendation: BUY Microsoft up to $28
• Microsoft five year performance: 2005 -2.13%| 2006 +14.19%| 2007 +19.22%| 2008 -45.39%| 2009 +56.79%| 2010 -12.92%
• This article was written for the free investment email The Right Side.
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