As a business, royalty companies treat investors like kings. In exchange for an initial investment, the royalty company receives a fixed percentage of the revenues.
If prices of the resources rise, the royalty company benefits. But once they’ve made the initial investment, the royalty company gets paid without having to worry about input costs, labor problems, or other managerial headaches.
A typical example would be a mine for gold and silver. Well-known companies like Silver Wheaton and Royal Gold operate as royalty companies. They deliver more consistent earnings outside gold and silver’s wild price swings.
Other companies operate along similar principles outside the mining sector. Coca-Cola sells syrup to its network of bottlers. McDonald's sells franchises and lets local management deal with issues that come up. It’s no surprise that these companies tend to have high profit margins: in addition to their strong brands, they can pass some of their operational risk off elsewhere.
This consistency is why mining royalty companies, McDonald’s, and Coke remain near their 52-week highs. Investors pay up for consistency.
One major royalty-like company, however, is bucking the trend. It’s none other than Microsoft (MSFT).
Many are quick to forget that Microsoft’s operating system was originally bundled with IBM’s computers. Microsoft received royalties for each computer sold.
As Peter Lynch once quipped, “No money manager ever lost their job investing in IBM.” But investors favoring the big stodgy company over one of their key suppliers missed out on the biggest technological trend of the past 30 years. The burgeoning personal computer market allowed Microsoft to leave IBM in the dust.
By the late 1990s, Microsoft had managed to get on the government’s radar for violating anti-trust laws. Their success bred the kind of contempt usually reserved for tobacco companies and banks.
But Microsoft is more than just a company churning out new operating systems. Microsoft bailed out Apple Computer when they were on the verge of bankruptcy with a $150 million cash infusion in 1997.
Microsoft invested over $200 million in Best Buy.
Just like Cisco, Microsoft is an unloved company providing an essential product that can’t be easily replaced or replicated. The company is a cash-cow, sporting over $30 billion in net cash, profit margins of over 30 percent, and a growing dividend that offers a 2.6 percent yield right now.
Of course, the company is drawing some criticism for the $8.5 billion it’s shelling out to buy Skype. But video-conferencing is a logical addition to the suite of core Microsoft products. It’s also consistent with the company’s history of buying up the best of what others have to offer.
Ironically, Microsoft and IBM are now neck-and-neck in terms of size.
Partially, it’s because IBM has been restructuring and improving its metrics. Partially, it’s because Microsoft has remained unloved.
Don’t let size fool you: At these prices, Microsoft has the upper hand on financial metrics. It pays out more to shareholders, its profit margins are twice as high, and it has a more diverse product offering than IBM.
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