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Microsoft shares better than its tablet?

Microsoft seemed to do a karaoke cover of a two year-old Apple hit earlier this week when it unveiled a tablet computer called the Surface.

The device looks like Apple's (AAPL) iPad with a kickstand and a cover that doubles as a keyboard. Pricing and availability weren't announced.

Stock investors have two reasons to keep expectations for the new device low. They're called Zune and Kin, Microsoft's 2006 music player and 2010 phone, both of which flopped.

But the stock market has a way of turning unsexy companies into alluring stocks. It does so by reducing share prices to modest levels relative to cash flows.

Microsoft Corp. (MSFT) has a stock market value of $250 billion, sits on around $40 billion in cash and generated more than $27 billion in free cash over the past year. Even if that rate slowed to $20 billion a year, the company would pay for itself in a decade.

The stock pays a 2.7% dividend and Microsoft in recent years has spent much more on share repurchases than dividends.

The challenges facing Microsoft are profound, of course. As websites take the place of locally installed programs, users become less dependent on running Microsoft's Windows operating system, a key cash generator.

And the company has largely missed out on the sweeping adoption of smartphones and tablet computers. Such devices take the place of personal computers for some, and introduce users to operating systems from Apple and Google Inc. (GOOG) .

To address these challenges, Microsoft later this year will launch a new operating system, Windows 8, that's designed to work on personal computers and tablets. Its new Surface tablet computer may be as much an effort to showcase this software as to gain hardware sales.

Meanwhile, Office 365 brings a cloud-based subscription model to the company's popular productivity software. And Azure provides a computing platform for developers of other cloud-based programs.

The basic plan seems to be: Extract as much cash as possible from the old model of software sales while trying to build a large, stable income under the new model. Windows 8 is likely to provide a short-term boost. Wall Street expects profits for Microsoft to increase 15% during its next fiscal year, which begins at the end of this month.

The key for stockholders will be what happens in the following year–whether income from cloud-based platforms and services grows quickly enough to make up for expected declines in installed personal computer software.

That might make Microsoft shares seem risky. But the riskiest stocks are those with ambitious valuations based on uncertain profits--like Facebook(FB) at 58 times this year's earnings forecast. At 11 times earnings, Microsoft is already priced like a company in decline, which means if it can merely preserve its income, to say nothing of growing it, the stock should pay off nicely.

That, however, hinges on the company doing wise things with its cash. Far more worrisome than its missteps with Zune and Kin was its 2008 offer to buy Yahoo Inc. (YHOO) at 66 times earnings. Yahoo has lost nearly two-thirds of its stock market value since then. Whatever the prospects for Surface, it surely will do better than that.

Jack Hough is a columnist at SmartMoney.com.