MicrosoftWhat's wrong with this picture?

Microsoft (MSFT) delivers blowout earnings, and shares open lower the following morning.

If you spotted the fact that the reaction to the event is exactly the opposite of what's expected, congratulations. You're well on your way to a perfect score on the English section of the SAT, if you ever decide to retake high school.

It's not that Microsoft is off a tremendous amount; its shares actually turned higher in early trading. However, it's a sign of a larger trend in technology earnings -- companies continuing to beat high expectations and their share prices subsequently flat lining, or worse, falling off a cliff.

Stodgy old tech titans like Microsoft and Intel (INTC) have been counted out as dinosaurs by many investors, yet each managed to easily surpass earnings estimates. The reaction: The market greeted them with a shrug the next day.

But before you dismiss Wall Street's muted reaction, consider this: Microsoft's shares aren't getting any love today because Wall Street has finally caught on to the company's game.

Microsoft Earnings Smoke and Mirrors

Here are the specific figures on Microsoft's earnings. Revenue hit $17.4 billion, an 8% jump over the previous year. Earnings were a whole different story; they bested the previous year's showing by a whopping 30%.

Great figures, right? Well, don't get ahead of yourself. For one thing, while Microsoft's earnings looked great, there's a component of smoke and mirrors involved. Namely, its operating income (calculated before interest and taxes) only increased 4% year-over-year. To Wall Street's credit, it's finally catching on to a game that's played by technology companies around the world.

Hey, That's a Nifty Tax Trick

The game is this: Make money overseas in areas with lower tax rates, and then avoid bringing the cash home to the United States. By bringing profits home, these companies would be subject to U.S. taxes that reach 35%. It's a nifty game because these companies get to report higher profits and get the double bonus of touting their huge cash piles. Don't you love a two-for-one deal?!

However, this is also a dangerous game. For one, many investors immediately give these companies credit for full cash on their books. However, since the companies don't want to trigger the huge taxes associated with bringing the cash home, it can't easily be used to do things that benefit shareholders, like pay dividends.

It isn't just Microsoft that's working overtime to avoid taxes; a raft of other U.S. companies are playing the same game. Intel's earnings also benefited tremendously from -- you guessed it -- a much lower tax rate.

Secondly, while this issue gets into very complex tax issues, it's extremely difficult to use the cash to make acquisitions in the United States without having to pay heavy taxes in the process. The end result is that companies are more inclined to make acquisitions abroad, where they're not subject to additional taxation.

Did you notice the fine print in Microsoft's recent $8.5 billion nonsensical acquisition of Skype? Microsoft managed to save billions of dollars by using foreign profits to buy Skype, which has its corporate headquarters in Luxembourg.

Microsoft made this bone-headed deal not because it was the best fit available for the company. They made the deal because it was a tax-efficient shot in the arm. If you're a Microsoft investor, this should scare you.

The Bottom Line

I don't begrudge these international titans for working within our tax system to reduce their payments. However, as an investor, I also don't give them credit for huge profit growth when their actual operating profits before taxes are showing anemic growth rates.

As ridiculous as the muted reaction to Microsoft's blowout quarter might look, it makes complete sense.


Motley Fool analyst Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of Microsoft and owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Intel and Microsoft, as well as creating a diagonal call position in Intel.


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ieyun313

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August 26 2011 at 2:27 AM Report abuse rate up rate down Reply
americandoo

"TIME FOR BIG INVESTORS TO STEP UP TO THE PLATE LEAD AMERICA BY
INVESTING IN AMERICA" "WHEN YOU INVEST IN AMERICA YOU INVEST IN YOUR CHILDREN'S
FUTURE"

"INVEST IN A LARGE PROJECT THAT WILL MAKE A DIFFERENCE FOR THE FUTURE"
Similar to this idea; In past history when the USA needed a Moral Boost to our
Country we built such things as; The Largest Bridges, Dams, Statue Of Liberty,
Worlds Largest Futuristic Fair, Landed on the Moon etc.

It is overdue for us and time for us to build the Largest & Best Futuristic
CITY IN THE WORLD, using ALL OF OUR CUTTING EDGE TECHNOLOGY­.

Countries CUTTING EDGE TECHNOLOGY and BEYOND ALL OTHERS ! !

Find a location in the USA somewhere that has the space for our "FUTURE CITY
PROJECT"

Where Our Future City will Utilize all of the Newest and Cutting edge combined
technology in the world to build our City using entirely GREEN energy with ZERO
POLLUTION ! ! !

Our City Could Have A NEW VERSION OF THE STATUE OF LIBERTY, Holding
the torch in one hand and our GREEN PLANET EARTH in her other hand, her head
raised high looking Up at the sky.

This would make a GREAT FILM based
on a True Story with the help of A TEAM OF BIG MONEY INVESTORS ! ! !

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ECONOMY ! ! ! !

"DREAM BIG...DO BIG"

Thank You, Respectful­ly, Michael V. Caldwell

August 05 2011 at 12:44 PM Report abuse rate up rate down Reply
kenneth

So much of MSFT's earnings were off-shore, as are the earnings of many of our multi-national corporations, such as GE, IBM, XON, CAT, et al. Since these earnings have not been "repatriated"--that is, brought back into the USA, they escape US Government taxation.
Admittedly, this is a problem. Can anyone offer a solution, short of a world-wide, uniform, tax system?
A few years ago, Congress offered a reduced-rate, limited repatriation deal designed to induce corporations to bring money back to the USA without paying the statuary 35%, but a much lower rate (I don't remember just how low). It was a modest success, and certainly not a long-term solution.
The current system does, indeed, encourage companies to invest overseas, which is, of course, detrimental to the US economy.
Someone, please help with a solution.

July 26 2011 at 12:41 PM Report abuse rate up rate down Reply
gillespiefrankie

When Obama favorite, GE made billions in profit and no taxes were paid, the media said nothing.

July 24 2011 at 11:10 PM Report abuse rate up rate down Reply
txryans

Ugh!!

July 24 2011 at 11:02 PM Report abuse rate up rate down Reply
Lorraine

im enjoying the airconditioning++++++++++++++++++

July 24 2011 at 7:56 PM Report abuse rate up rate down Reply
feeberoo

It seems I saw ads on T.V. by the elder Gates that we should raise taxes on the rich because people, such as he, could afford to pay more in taxes. Now I'm hearing that a lot of their money is "over there" and not taxable?

July 24 2011 at 7:50 PM Report abuse rate up rate down Reply
DDerr

These companies still pay overseas taxes. If our government wasnt lost and out of control, they wouldnt need to tax the breath out of us. But... the US government under Bush cut taxes, while running the most expensive government the US ever had. He gave tax rebates by having the Federal Reserve print up $200 Billion! He took our economy from ZERO DEBT, to 11 TRILLION DOLLARS! He then passed that on to the next idiot, Obama, who has spent money on bailouts and programs.... like he actually had the money! Soooo... now our inept government is going to make us pay for its mistakes by raising taxes, and adding taxes all the hell over the place.
FOLKS, WE NEED TO VOTE EVERY ONE OF THESE IDIOTS OUT OF OFFICE, TIL WE HAVE PEOPLE WITH GUTS WHO WILL START FIRING THEIR OWN GOVERNMENT, AND START HONORING THE SOUND ADVICE AND GUIDELINES IN THE CONSTITUTION... you remember, the Constitution they swore on a Bible to uphold?

July 24 2011 at 4:34 PM Report abuse rate up rate down Reply
1 reply to DDerr's comment
DiverNW

DDerr, learn the difference between DEBT and DEFICIT. But didn't start with ZERO DEBT, not even close.

July 24 2011 at 5:01 PM Report abuse rate up rate down Reply
BERNIE/LOIS

Lawyers makes this all possible....................wonder how many of them died in recent wars?

July 24 2011 at 4:12 PM Report abuse rate up rate down Reply
oakcourt

Cut Taxes!.....Avoid Taxes!........That is the game we are all caught up in. That is why America has been raped so many times...........Fortune 500 Companies know how to get around any obstacle. I worked for several, and as a Inter-Co.
accountant, companies setup "loans" on their books to get funds distributed where it is needed. They just pay interest.
Until we overhaul the tax system and make it more efficient and competitive with other countries, the shenanigans will continue..............

July 24 2011 at 3:31 PM Report abuse rate up rate down Reply