Monday, January 26, 2009

February 2009 Investment Pick

You may have noticed that I did not call this month's pick a "Stock Pick." If you think that was intentional, you're right. It's an option contract. Some of you may not have options trading available to you at your online discount broker, and if that is the case, I do not recommend buying the underlying stock, but rather the stocks that I have recommended earlier in this space.

But for those of you authorized to trade options, I think this is a doozie. If you buy Microsoft (MSFT) call options, that is, the right to buy at a certain "strike price" until a certain date in the future, you can buy options that don't expire for another 2 years - Jan 2011! Some of these calls have a strike price of $17.50 (x100), and are selling for $4.20 (x100). The underlying, that is, MSFT, is selling for $17.75 or so per share. Think about this for a second. If the largest, most profitable technology company in the world goes half of the way back to its 52-week high ($35.00), it will be at $26, and call holders will have doubled their money - far more than they would have made if they had owned the stock. If MSFT goes all of the way back to its 52-week high, holders of these calls will have quadrupled their money, while shareholders would be crossing their fingers hoping for the double to be consummated.

Of course, there is greater risk if the share prices stagnates or dips a little over the next two years. If MSFT does not go up much over the next two years and ends up in January 2011 where it is now (January 2009), call holders will be wiped out - they will have lost everything, while shareholders will have lost little but their time.

I find that possibility relatively remote. Microsoft, despite horrible news about Zune, bad PR for Vista, and occasional setbacks for Xbox, is one of the most profitable companies in the world. It has profit margins unheard-of for such a large company, and is trading for a P/E (price divided by earnings, or profits) of less than 10. Less than 10! If you had told a stock jock in 1999 that Microsoft would someday trade for a P/E of 10, he'd slap your face. That was blasphemy in those days.

It's as though people are going to stop buying the cheap, buy-one-get-Internet-Explorer-free computers during the recession/Depression, and the cash on Microsoft's balance sheet is going to disappear in boondoggles. Let me tell you, in recessions and Depressions, large cash-rich companies thrive, not suffer. Watch for Microsoft to grow during the current recession, especially if we get the inflation I'm expecting. Microsoft, being relatively free of capital investment requirements, is inflation-resistant in its costs and its pricing, and will be more and more affordable as people see their incomes "rising." Their stock price will thus have a rising tide of inflation to buoy it over the next two years.

Remember, MSFT has dropped from $35 to $17.75 in less than a year. You have two years for it to get back to $35, and it doesn't even have to go that far. Considering MSFT's low P/E, high profit margins, cash-rich balance sheet, and the low premium for these long expiration call options, I recommend buying VMFAW for under $4.50 (currently at $4.10).

ETF update: I recommend iShares Singapore (EWS) at $6.50 and Hong Kong (EWH) at $10.00 in addition to iShares Australia (EWA).