Serious Money: Regulation and competition are the tech giant's main bugbears but, with its cash mountain, an investment in the stock should prove to be profitable, writes Chris Johns

Are Microsoft shares worth buying? In many ways, a decision about whether or not to own stock in the giant technology company provides valuable lessons in how to evaluate any prospective investments.

An assessment of current valuation plus a guess at future growth prospects is the starting point of any analysis of equities. Microsoft's status as a technology bell-wether stock also allows us to make a stab at the overall outlook for the key tech sector and the market as a whole.

Any assessment of a technology company involves more guesses than usual. The likely path of future scientific innovations fills the pages of many business newspapers, including this one, and the potential investor is often left wondering about the intrinsic ability of anyone to see how new technologies might emerge and evolve, let alone who will profit from them. The past is littered with famous errors made by seers who forecast the probable shape of technological developments.

A chief executive of IBM once famously declared that the demand for computers was not likely to reach double digits; phone companies completely missed the demand for text messaging; and confident forecasts for the integration of TV and home PCs have proved wide of the mark.

Successful gamblers on pure new technology plays tend to be high-risk venture capitalists who invest in dozens of start-ups in the hope that one will become the new Microsoft or Intel. Fully acknowledging that the technological future is largely unknowable, they marry the insights of expert techies with the instincts of the lottery player who buys several tickets to maximise his chances.

The personal investor is left in an extremely weak position, with even less access to the limited information available about future growth areas.

Companies such as Microsoft offer the investor the opportunity to participate in technology without the need to make specific guesses about where the next scientific advance will come from. A proven ability to innovate and also to profit from other people's inventions means that we can invest in companies that we are reasonably confident will be leaders in the field, leaving the guesswork about specific technologies to others.

The downside is that Microsoft and other similar mature companies are unlikely to again offer the super-charged growth that they displayed in their youth - the growth that the venture capitalists are still searching for. They are most unlikely to be at the top of the league table of technology performers.

Indeed, Microsoft's detractors argue that the company's competitive position is under threat from so many sources that it will struggle to grow at all and that its share price will under-perform for many years. They suggest that the stock's valuation is still pricing in an unlikely growth rate and will come under further pressure, no matter what the broader market does. Microsoft's very size means, for the doubters, that its ability to grow at all is severely compromised.

With a price/earnings ratio of around 32 and a dividend yield of just under 1 per cent, Microsoft is most definitely pricing in a high growth rate. At the heart of valuation analysis is the question of just what that implied growth rate actually amounts to.

The workhorse of finance theory, the dividend discount model (which underlies all valuation analysis), suggests that the implied long-run growth rate of earnings and dividends of Microsoft is somewhere in the high single digits, perhaps as much as 10 per cent a year, depending on the assumptions that we use.

Now, that's a long-run average: for a young company a lot of the growth might come in its early years before settling down to a more sedate rate. Microsoft does not fit into that category. Certainly, no company can grow its earnings at 10 per cent a year for ever, particularly one as big as Microsoft. It would quickly become bigger than the US economy, which is a nonsense proposition.

But Microsoft's existing levels of profitability are awesome and its ability to generate cash is truly prodigious. If it wanted to, the company could pay a much larger dividend, for example, and hardly notice the difference. Current pure cash generation is running at around $1 billion (€0.8 billion) a month and the cash pile sitting on the balance sheet is just under $60 billion and growing.

When this company moves, it will have no peers anywhere in the world: its ability to buy other assets (companies) is limited only by the attention of the regulators and its ability to improve the profitability of those potential investments. Alternatively, it could use the money simply to buy back its own shares.

Some analysts believe that a huge buy-back programme is imminent - something that should boost the share price.

Regulation and competition are the two monkeys on Microsoft's back. It has settled with the US authorities and is still doing battle with EU regulators.

Far from worrying about regulation, I think the authorities have done investors a favour: they have identified one of the most profitable companies in the world. Whether or not it makes those profits from dubious practices is almost beside the point. We want to invest in the most profitable companies: Microsoft fits that description in spades.

Competition comes in many guises but the most prominent is Linux, the free (or open-source) operating system that competes most directly with Microsoft's core business. How Microsoft meets this threat will largely determine the company's future.

It is easy to get worried about Linux, with adoption rates seemingly extremely high. Examples are legion with none more prominent than in the movie business: virtually every film showing on screens today is made using graphics that run on Linux-based systems.

Not surprisingly perhaps, Mr Steve Balmer, Microsoft's chief executive, says he is more confident than ever about the company's future. Cost-control, boring though it is, has become a much needed key part of his strategy.

The breadth and profitability of Microsoft's activities are growing. I am confident that he will maximise the potential of the cash mountain.

Microsoft's shares are currently in the middle of the trading range established over the past 12 months. It has become fashionable to knock Microsoft from many different perspectives, something which has depressed the share price. They may not prove the most exciting of investments but I think they will be a profitable one.