Value Investor’s Favorite Mistake
While not exactly the same, value investing and contrarian investing often go hand-in-hand.
Value investors hunt for under-priced stocks based on irrefutable fundamentals while contrarian investors search for deals on investments that no one else wants. They often arrive on the same stock, and most value investors would also identify themselves as contrarians.
So when all the value investors agree on the same stock, can they still be contrarian?
No they can’t.
And I think they’re dead wrong on one stock.
The recent darling of value investors is Microsoft (NYSE: MSFT). On fundamentals alone, it does look cheap. In fact, Dan Ferris, the editor of Extreme Value, points out that Microsoft has enough cash and cash flow to buy out all its shares and make itself private.Ă‚ (Not incidentally, Dan Ferris gets my highest possible rating as a value investor. We happen to disagree on this one.)
But here’s my hang-up. Analysis like that always considers Microsoft a dominating brand with a moat that will keep competitors at bay. It always assumes that Microsoft has a lock on its futures revenues and earnings.
That’s simply not the case.
Microsoft Maintains Its Stranglehold
Yes, Microsoft maintained a long-time stranglehold on the operating system. I expect that grip to be broken. As for the rest of its business…
It seems like everything else it does is a flop. The Zune is a good example. In its first year and a half of production, Microsoft moved 2 million Zunes. Over the same period, Apple sold 76 million iPods. Last quarter, Zune sales fell 54%… so I don’t think the gap is closing.
Microsoft sold their first Xbox for less than it cost to make, intending to make up the difference on game sales. They vowed to investors not to do the same with the Xbox 360, but investigators expect that it costs $310 to make and sells for $299. Xbox has started to pull ahead of the Sony Playstation, but it hasn’t stopped the Nintendo Wii.Â
In FY 2008, Microsoft spent $8.1 billion in research and development and I haven’t seen much come out aside from Vista, a widely loathed new version of Windows, and the much-ridiculed Songsmith. (Warning: click that link only if you have a strong stomach for bad music.)
But who cares right? As long as they still dominate the operating system, they can have a few failed side projects, right? Maybe, but it’s a moot point since the operating system market is changing.
Microsoft (NYSE: MSFT) 2005 Till Now
In 2005, Microsoft Windows controlled 96.18% of the market, last month it’s down to 88.1%. Meanwhile, Mac’s share rose from 3.41% to 9.9%. In 2002, the two most recent versions of Microsoft’s Internet Explorer held 83.4% of the browser market. It’s now down to 45.7% with Mozilla’s Firefox going from 0% to 44.4%.
Another competitor is the family of completely free Linux operating systems. They used to be held back by complexity and a steep learning curve. Every few years, I’ve loaded a computer with Linux to check out their progress. It’s substantial. You can start a PC with the operating system Ubuntu and load it with virtually every program you could need, completely free, and be up and running from day one.Â
With PC and IT investment plummeting, more people than ever will be willing to spend a few hours learning a new operating systems if it comes with a $0 price tag.
When the network effect of the operating system market decreases, the value of any of Microsoft’s other products drop exponentially.
Admittedly, I’ve been a little tongue-in-cheek with this assessment, but my point is this: I wouldn’t bank on Microsoft’s moat, because it looks like it’s being drained.
Matt Weinschenk,
Senior Analyst, The White Cap Report
www.investmentu.com
While not exactly the same, value investing and contrarian investing often go hand-in-hand.
Value investors hunt for under-priced stocks based on irrefutable fundamentals while contrarian investors search for deals on investments that no one else wants. They often arrive on the same stock, and most value investors would also identify themselves as contrarians.
So when all the value investors agree on the same stock, can they still be contrarian?
No they can’t.
And I think they’re dead wrong on one stock.
The recent darling of value investors is Microsoft (NYSE: MSFT). On fundamentals alone, it does look cheap. In fact, Dan Ferris, the editor of Extreme Value, points out that Microsoft has enough cash and cash flow to buy out all its shares and make itself private.Ă‚ (Not incidentally, Dan Ferris gets my highest possible rating as a value investor. We happen to disagree on this one.)
But here’s my hang-up. Analysis like that always considers Microsoft a dominating brand with a moat that will keep competitors at bay. It always assumes that Microsoft has a lock on its futures revenues and earnings.
That’s simply not the case.
Microsoft Maintains Its Stranglehold
Yes, Microsoft maintained a long-time stranglehold on the operating system. I expect that grip to be broken. As for the rest of its business…
It seems like everything else it does is a flop. The Zune is a good example. In its first year and a half of production, Microsoft moved 2 million Zunes. Over the same period, Apple sold 76 million iPods. Last quarter, Zune sales fell 54%… so I don’t think the gap is closing.
Microsoft sold their first Xbox for less than it cost to make, intending to make up the difference on game sales. They vowed to investors not to do the same with the Xbox 360, but investigators expect that it costs $310 to make and sells for $299. Xbox has started to pull ahead of the Sony Playstation, but it hasn’t stopped the Nintendo Wii.Â
In FY 2008, Microsoft spent $8.1 billion in research and development and I haven’t seen much come out aside from Vista, a widely loathed new version of Windows, and the much-ridiculed Songsmith. (Warning: click that link only if you have a strong stomach for bad music.)
But who cares right? As long as they still dominate the operating system, they can have a few failed side projects, right? Maybe, but it’s a moot point since the operating system market is changing.
Microsoft (NYSE: MSFT) 2005 Till Now
In 2005, Microsoft Windows controlled 96.18% of the market, last month it’s down to 88.1%. Meanwhile, Mac’s share rose from 3.41% to 9.9%. In 2002, the two most recent versions of Microsoft’s Internet Explorer held 83.4% of the browser market. It’s now down to 45.7% with Mozilla’s Firefox going from 0% to 44.4%.
Another competitor is the family of completely free Linux operating systems. They used to be held back by complexity and a steep learning curve. Every few years, I’ve loaded a computer with Linux to check out their progress. It’s substantial. You can start a PC with the operating system Ubuntu and load it with virtually every program you could need, completely free, and be up and running from day one.Â
With PC and IT investment plummeting, more people than ever will be willing to spend a few hours learning a new operating systems if it comes with a $0 price tag.
When the network effect of the operating system market decreases, the value of any of Microsoft’s other products drop exponentially.
Admittedly, I’ve been a little tongue-in-cheek with this assessment, but my point is this: I wouldn’t bank on Microsoft’s moat, because it looks like it’s being drained.
Matt Weinschenk,
Senior Analyst, The White Cap Report
www.investmentu.com
