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Learning From Microsoft’s Investors’ Mistake

Microsoft (NASDAQ: MSFT), the company behind the ubiquitous Windows operating software found in computers around the world, announced last Friday  that its chief executive Steve Ballmer was stepping down after 13 years at the helm.

The market greeted Ballmer’s decision with glee and Microsoft’s stock actually shot up 7% to US$34.75 on the day of the announcement, signalling the financial public’s widespread discontent with the chief executive.

Critics cite Microsoft losing out the Internet war to Google as well as the mobile war to both Apple and Google as examples of Ballmer’s failure to lead. In addition, they also point out how Microsoft’s stock had gone nowhere since he took over as CEO on 13 Jan 2000 as further proof of Ballmer’s culpability – according to Yahoo Finance, Microsoft’s stock was trading at a dividend-and-split-adjusted price of US$39.99 on 13 Jan 2000.

So, it seems that if investors were to learn a lesson from Microsoft’s decade-plus of flat returns, it would be to invest in a company with a better leader, right? Well, not quite.

If anyone actually took the time to analyse Microsoft’s corporate performance since 2000, it seems that the company’s much-hated chief executive might even be slightly maligned.

Here’s how Microsoft did in Ballmer’s 13 years. It nearly tripled its earnings per share from a split-adjusted US$0.905 for the financial year (FY) ended June 2000 to US$2.61 for the FY ended June 2013. The company’s revenue also grew by 240% from US$23b to US$77.8b in the same time period.

With such results, it’s hard to point an accusatory finger at Ballmer and conclude that he had lost it.

So, What Went Wrong?

If Microsoft’s corporate performance wasn’t the issue for its disappointing share price (despite losing out to both Google and Apple in capitalising on important technological trends), then what is?

Turns out, it was likely a result of valuation. According to Morgan Housel at The Motley Fool US, Microsoft was trading at a Price-Earnings ratio of 72 on the day Ballmer became CEO. At such valuations, it’s tough to for any company to live up to the lofty expectations the market expects from it.

And if anything, it was the investors who made a mistake for viewing Microsoft through the rosiest-of-tinted-glasses. Unfortunately, it’s also a scenario we’ve seen in the local market.

So, What Went Wrong Here?

Marine engineering firm Sembcorp Marine’s (SGX: S51) trailing-12-months’ earnings per share was at S$0.145 on 11 October 2007 and has since grown by 74% to S$0.252 as of 28 August 2013.

That’s great earnings growth from SembCorp Marine. But unfortunately, its shares have actually gone down by 21% in that time.

Investors in the company might be able to say they’ve beaten the market as the Straits Times Index (SGX: ^STI) is actually sitting on a 22% decline, (11 Oct 2007 is the day the STI peaked at 3,876 points before the Great Financial Crisis went into full swing), but that’s scant consolation.

If we go through the post-mortem, the reason for the discrepancy between corporate performance and stock price return can probably be pinned down to Sembcorp Marine’s elevated PE ratio at that time, which signified high expectations that it would find hard to live up to.

Sembcorp Marine 11 Oct 2007 28 Aug 2013
Share Price S$5.35 S$4.23
PE Ratio 37 17

Foolish Bottom Line

I recently shared a piece of advice from Warren Buffett in an article on how investors should focus on corporate results instead of stock price performance as a basis for measurement in determining the success of the stock pick itself as “intrinsic business value is the eventual prime determinant of stock prices.”

But there was also a very important caveat that was mentioned in the article – a reasonable price has to be paid in relation to underlying value.

So while Sembcorp Marine and Microsoft had great corporate performances, over the last five-odd years and 13 years respectively, their shares couldn’t grow at all due to what was arguably (though admittedly, on hindsight) an unreasonably high price in relation to value.

That’s something for investors to keep in mind.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.