The bottom-up approach works in the opposite way starting at the company level and then going up to industry and the overall economy. Fundamental analysis has its strengths in forecasting long-term trends, determining the company's fair value in terms of asset valuation, strong balance sheet, earnings stability, and staying power1.
There are certain risks involved in any stock investments. A company may face one or more of the several sources of fundamental risk, namely, business risk, financial risk, liquidity risk, exchange rate risk, country risk, interest rate risk, and credit risk2.
Domiciled in Seattle, US, Microsoft has its offices in 100 countries. As per the information excerpted from its annual report for the year 2006, Microsoft reported a net income of $12.5 billion. Such profitability, however, does not get achieved without taking risks. Investors need to be aware of what risks Microsoft tackles with in order to satisfy its stakeholders.
Microsoft, in its operations, encounters business risk which is the risk reflecting uncertainty in cash flows caused due to a number of reasons. Microsoft faces intense competition across all markets for its products and services.
Its competitors range from Fortune 100 companies to small, specialized single-product businesses. With low barriers to entry, this business segment is facing a fierce competition worldwide. These competitive pressures have the capability to threaten Microsoft's sales volumes and operating costs resulting in lower revenue. Microsoft faces a challenge in combating unlicensed use of its software and intellectual property rights3. It spends a fortune every year to educate the public regarding abuse of its software. However, continued educational efforts may not succeed in implementing Microsoft's desired security objectives and any reductions in the legal protection of its intellectual property rights can adversely affect revenue. Due to its geographic dispersion, Microsoft is subject to tax risk. Tax risk affects investors because it affects net earnings4. Being accountable for tax in the US as well as numerous foreign jurisdictions, there is uncertainty over Microsoft's tax liabilities. Therefore, tax provisions may not be accurate which can significantly impair its earnings. Other examples of business risk that may affect Microsoft's revenue are delays in product development, lawsuits and claims, changes in accounting standards, and maintaining uniformity in pricing structures due to global presence.
Another challenge for Microsoft is to tackle with market risk that comprises of foreign exchange risk and interest rate risk. It is quite obvious that having operations worldwide Microsoft is deemed to face risk of foreign currency losing value relative to its domicile currency. However, as mentioned in its annual report, Microsoft manages this risk by hedging its foreign exchange exposure and constantly monitoring it to maximize its overall effectiveness. The