How Does Microsoft Need To Do Vs. Apple Inc (NASDAQ:AAPL)?

It’s a special time of the software cycle for Microsoft Corporation (NASDAQ:MSFT): new versions of Windows and Office are set to roll out, and while the company has survived disastrous Windows editions in the past it feels as if Windows 8 is particularly important in terms of establishing Windows as an operating system for tablets (as well as, of course, generating sales from the core PC user base). On top of that, Microsoft (possibly because it was frustrated with the slow pace of other hardware manufacturers) is introducing Surface, a tablet of its own which is conceptualized as being more for business use. For example, the signature keyboard cover is intended to appeal to professionals who even on the go will do more typing than Angry Birds.

Microsoft’s most recent quarter, the first of its fiscal year, saw an 8% decline in revenue from a year ago, which might not be quite as bad as it appears since many potential customers may have put off making purchases until Windows 8 is released. Microsoft’s costs grew- including costs of goods sold, even though sales had been down- and earnings per share for the quarter came in at 53 cents, compared to 68 cents in the first quarter of the last fiscal year. Microsoft Corporation trades at only 10 times expected earnings for this year (and only 14 times an annualization of last quarter, which we’ve acknowledged may have been abnormally low). It looks to us like the market is pricing the stock fairly cheaply, as a standard run rate would provide higher earnings and there should be a kick to net income over the course of the year.

Ken Fisher FISHER ASSET MANAGEMENT

Billionaire Ken Fisher’s Fisher Asset Management is one of the major holders of Microsoft Corporation stock tracked in our database of 13F filings. The fund reported a position of about 18 million shares at the end of June (find more stocks owned by Fisher Asset Management). Renaissance Technologies, which was founded by now-billionaire Jim Simons, nearly doubled its stake during the second quarter to a total of about 16 million shares (see more stock picks from Renaissance Technologies).

Microsoft’s closest competitors are Apple Inc. (NASDAQ:AAPL) and Google Inc (NASDAQ:GOOG). Read our latest analysis of Apple. Apple’s share price has been dropping recently, so much so that it now trades at a trailing P/E of only 12. With Wall Street analysts expecting some degree of the company’s recent growth rates- earnings last quarter were up over 20% from the same period in 2011- the five-year PEG ratio is 0.5 for what everyone acknowledges is a power player in tablets and smartphones. Microsoft may be cheap, but we think that Apple is an even better buy. Google is probably a stock to hold off on for now, however: it hasn’t been too successful at integrating Motorola Mobility Holdings, and earnings are down as that business remains unprofitable. Analyst expectations are that the company will improve in 2013, and it trades at 14 times consensus earnings, yet we think Microsoft and Apple look like better buys right now.

Oracle Corporation (NASDAQ:ORCL) and Amazon.com, Inc. (NASDAQ:AMZN) are also peers for Microsoft’s business software and tablet offerings, respectively. Oracle looks like another potential value play, as it carries trailing and forward P/E multiples of 15 and 10 respectively and has been getting moderate growth in net income. We think that we might take a closer look at that company. Amazon, meanwhile, continues to trade at a valuation of about $100 billion despite being barely profitable; even on a forward basis, its P/E is over 100 and those estimates incorporate assumptions of very strong growth. We think that stock is overvalued, and would consider shorting it against a long position in Apple or Microsoft.

Microsoft’s new product launches are a risk, but based on its valuation the market seems to have low expectations for the business’s performance over the next year. If the company looks like it can hit the Street’s earnings target, that would probably make the stock a buy.

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