If Microsoft (Nasdaq: MSFT) were on a reality show, it would be the contestant who consistently outperforms its flashier rivals to the constant surprise of the viewers. Investors should never overlook three vital factors about the software giant that have resulted in its commanding so many business sectors.

Microsoft innovates
Despite the belief of some commentators , Microsoft is a very innovative company, having come first with operating systems for the cloud, which delivers computing services over a network, and Big Data, the collection of large and complex information packages, as but just two contemporary examples. In its ascension from a garage start-up  to now having the third-largest market cap of any publicly traded company, Microsoft has supplanted competitors such as IBM (NYSE: IBM), Oracle (Nasdaq: ORCL)and Novell in key market segments.

This continues today with the gap between Xbox and Sony's (NYSE: SNY) PlayStation broadening in the gaming system segment.  The Windows 8 operating system for smartphones, now being offered through Nokia (NYSE: NOK) and others, is projected by International Data Corporation to almost quadruple its market share by 2016.


The following products manifest the evolving innovation efforts of Microsoft:

  • Its Azure was the first cloud-based operating system, long before Google (NAS: GOOG) Chrome.
  • Windows 8 SmartPhone, which has contributed to Nokia and its "bounce back" of a 60% jump over the last quarter due to the improved Lumia 920 smartphone, competes against the iPhone 5 from Apple, and the Droid from Samsung/Google.
  • System Center 2012, the only unified platform that offers improved capabilities for managing information technology systems.

While some still claim that Microsoft does not innovate, that is certainly not the opinion of Steve Wozniak, co-founder of Apple (Nasdaq: AAPL). In a recent interview, Wozniak expressed concerns that Microsoft is more innovative than the product developers for Apple. He laments: "I fear that Microsoft might have been sitting in their labs, trying to innovate, with a formula: 'How do we come up with new ideas? Let's not keep doing the same things as before, just the newer versions of them.' They might have been doing that for three years, while Apple was just used to cranking out the newest iPhone and falling a little behind. And that worries me greatly." 

Microsoft dominates
Windows is the world's most popular operating system. Microsoft has sold over 500 million licenses for the Windows 7 operating system. It is also the fastest-selling operating system in history. Almost half of the operating systems for PCs today are Windows 7. 

Microsoft did not start out at the top. It had to dispose of Novell to dominate in the server OS segment . It seized market share from Oracle in the database sector. There have been more than 70 million Xbox 360 consoles sold in direct competition with Sony (NYSE: SNY). For the first time, in 2011 Microsoft sales of the Xbox 360 for the year topped those of Sony's PlayStation 3.

For future growth, the cloud is another area that Microsoft has targeted with Azure, Windows 8, and its tablets Logically, Microsoft has cloud-based advantages through its dominant market share of both Windows for consumers and Windows Server in the data center. There is certainly a formidable challenge from Google, but the institutional presence of Microsoft will be tough to supplant. 

For those companies looking to move up, there is the Microsoft Office 365, which is a cloud-based solution for business operations. Firms using Windows 7 that move to the cloud can now use mobile client systems for better performance and greater efficiency.

Microsoft's financials are great
A great balance sheet and income statement are the fruits of the way Microsoft innovates and dominates. This results in a very balanced business model for Microsoft, with more than one-third of its revenue from the Business Division, one-quarter from server and tools, and about one-fifth from Windows & Windows Live Division.

As the table below shows, Microsoft outperforms the industry average in many areas. Due to its size, it will not have the sales growth rate of smaller rivals. However, its superior earnings-per-share (EPS) growth rate evinces how well the stock has performed. The strong earnings allow for a dividend yield that is higher than the industry average and tops those off Apple, IBM, Oracle, and Google. That Microsoft has been able to maintain a net profit margin over 20% while the industry average has collapsed to just 0.23% is particularly demonstrative of how well it is performing compared to its rivals.

Metric

Microsoft

Industry Average

5-Year Sales Growth Rate

5.74%

12.72%

5-Year EPS Growth Rate

11.92%

11.81%

5-Year Return on Assets

19.50%

13.70%

5-Year Return on Investments

32.90%

22.50%

5-Year Net Profit Margin

28.00%

21.60%

Net Profit Margin Trailing 12 Months

21.70%

0.23%

Dividend Yield

3.50%

1.70%

Source: The Motley Fool CAPS.

For the Foolish investor
Microsoft's profit margin is the key metric to follow. Being far superior to the industry average, it very clearly demonstrates the company's innovation and dominance. Foolish investors should buy Microsoft on the dips, as the dividend yield will add to an even greater total return when the stock rebounds. If the Blackberry 10 smartphone from Research In Motion sells well after its Jan. 30 release,  Microsoft could dip as the market overreacts to a perceived threat in the smartphone market. But it should recover quickly since the Blackberry 10 is more of a threat to Nokia or Apple.

 That will be an opportunity for Foolish Investors to purchase shares at a discount. Microsoft will remain a compelling buy due to its innovation, domination of key sectors, and strong financial performance.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

The article 3 Reasons You Can Profit From an Underrated Tech Giant originally appeared on Fool.com.

Jonathan Yates has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, IBM, Microsoft, and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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