The market was concerned that declining PC sales – and Microsoft's inability to successfully navigate the mobile space – would doom the company. But analyst Dan Ferris, who holds Microsoft in his portfolio, was still bullish on the stock. After all, the company is still producing nearly $30 billion of cash a year and has nearly $80 billion of cash on its books. Plus, Dan argued, individuals' waning interest in PCs didn't hurt Microsoft as much as everyone believed.
In August, Dan wrote: The Wall Street Journal and investment bank Goldman Sachs seem to think PC users – individuals and small businesses – are Microsoft's primary customers. And they're betting Microsoft will fail because of the growing popularity of mobile-computing devices among individual consumers. That's not true. Microsoft makes more money selling to big businesses than to all other customer types combined.
In a presentation at the 29th annual Sanford C. Bernstein Strategic Decisions conference this May, former Microsoft COO Kevin Turner showed the audience a chart called "customer segments." The chart clearly indicated the percentage of its revenue that Microsoft earned from each of the four customer bases it serves.
Everybody loves to criticize Microsoft for failing to serve individual consumers as well as Apple and other companies. The correct response to this observation is, "So what? It doesn't need to serve them as well as Apple does. The real story at Microsoft is the enterprise."
Then on August 23, Microsoft CEO Steve Ballmer announced he would step down within 12 months. Ballmer's been lambasted for some poor acquisitions (which we'll discuss later) and failing to compete in the mobile market. The market applauded his departure, sending shares up 7% on the news.
Dan wasn't as down on Ballmer as the rest of the market. In an update to readers, he wrote: Microsoft sales have grown more than 10,000-fold – from $7.5 million to nearly $78 billion – since Ballmer first joined Microsoft in 1980. Since he became CEO in January 2000, Microsoft revenues have risen from $22.9 billion to $77.8 billion. Net profit is up from $9.4 billion to $21.9 billion.
Microsoft initiated a regular dividend in 2003, and the annual payout has risen from $0.08 per share to $0.92, a compound annual growth rate of about 28% a year. Ballmer hasn't been a perfect CEO. But it's hard to believe he gets none of the credit for more than tripling Microsoft's sales and more than doubling its profits as CEO. Dan said Ballmer's departure was neither great nor terrible. And Microsoft's intrinsic value didn't increase 7% with his departure (just as it didn't drop 11% following the earnings announcement).
That brings us to this week: Microsoft announced on September 3 that it would buy Nokia's devices unit for $7.2 billion. Nokia is the struggling Finnish cell-phone company that failed to "break through" into smartphones. Nokia CEO Stephen Elop will move to Microsoft following the transition and represents a possible successor to Ballmer.
The deal with Microsoft takes Nokia completely out of the handset market. It's left with a pile of cash and NSN – the company's maps and advanced technology division (basically research & development and various patents). One of my contacts, a senior executive in the technology space, wrote me with his thoughts on Nokia's current situation. My guess is that they [Nokia] are going to take the cash and make a strategic acquisition that is complimentary to the NSN assets in order to complete the transformation of the company. The stock jumped 40% initially on the news.
As for Microsoft, it's clear the software giant is making a big push into smartphones. It's hoping its scale and technology combined with Nokia's mobile know-how will help it compete against the likes of Apple and Samsung. But the market isn't so sure. Microsoft fell nearly 6% on the news.
The market has good reason to question Ballmer's latest acquisition – his potential final black eye for capital misallocation. He hasn't made the best decisions in the past.
In 2007, Microsoft bought digital marketing and service provider aQuantive for $6 billion. Late last year, Microsoft took a $6.2 billion write-down to its Online Services Division. The write-down was related to the goodwill from the aQuantive acquisition. Acquiring companies carry goodwill on their balance sheet equal to the amount paid above the target company's book value; and Microsoft wrote down the whole lot (and then some).
Microsoft also spent $8.5 billion in October 2011 to buy Internet phone service provider Skype – more than three times what eBay paid for Skype in 2005. (And eBay couldn't make the investment profitable even at the lower price.) Time will tell how the Nokia acquisition works for Microsoft but the company has a spotty history of acquisitions. That hasn't stopped it from being an incredible investment, though.
Microsoft is a classic example of the kind of business Dan calls a World Dominator. These rare businesses sell the No. 1 product or service in their field. They have tremendous competitive advantages over their rivals that make it nearly impossible to compete with them. They generate consistent and often thick profit margins and generate tons of free cash flow year after year. And many pay generous and growing dividend streams.
Dan tracks 11 World Dominating Dividend Growers in his newsletter. We've mentioned many of these businesses in the past – names like consumer-products giant Johnson & Johnson and retail colossus Wal-Mart. Simply buying and holding these companies in your portfolio is one of the surest and safest ways to make money in the market.
Dan says that many people think these stocks only outperform over the long term, but that's not true. Remember, the trick is to simply hold these stocks forever. You will compound your wealth at amazing rates.
We say the timeline for holding capital-efficient stocks is "forever," many people think only young people can buy these stocks. Older investors won't have time to enjoy the miracle of compounding but that's not true. The notion that these companies are only better over the long term is wrong. These companies frequently perform better over any period but they're always better in the long term. So investing in them is the smart thing to do with your capital in any case. The key, of course, is buying at the right price.
Any investment – no matter how strong the business – will struggle if you pay too much for it. Most of the time, you don't have the chance to buy stock in well-run and highly regarded businesses for a bargain. But when you do, you should load up.
Dan's standards are extremely high. He's extremely patient waiting for bargain prices. He waits for rare times when you can buy trophy beachfront estates for ghetto prices. These opportunities are rare but they do occur in the stock market. When you see them, don't hesitate. They don't last long. Take advantage of them with substantial position sizes. These positions can help build a lifetime of worry-free wealth. Right now Microsoft is trading for less than the buy-up-to prices he's set for them.