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| Image: Microsoft |
Today, MSFT seems almost like a lost cause, having floundered for 10 years with its share price going nowhere. With its PE ratio this cheap (10.4x trailing twelve months), coupled with strong cashflows, MSFT is a monopoly priced like a sunset industry.
With its products spanning a wide range from the X-box for the gaming crowd, to its ubiquitous Windows OS and Office suite for the business people, and consumers too, MSFT seems extremely cheap for what is among the most universal of all brands and products. And we haven't even factored how it might dominate in cloud, which is lauded as the next big thing. Is MSFT a good value-play?
Microsoft Corporation (NASDAQ: MSFT)
5 Oct 10
P=23.91
MSFT’s FY10 ends Jun 30 10.
Prima Facie:
MSFT is now trading at close to 52 wk lows (22.73-31.58) and PER_ttm of 11.4x. MSFT has had consistent performance in its EPS, having had steady earnings growth over the last 10 years with pullbacks only in 2004 and 2009. Its PER trades from 9-58x in last 10 years, and in last 3 years from 9-19. So a 15x PER is not ambitious. At 11x PER, it is trading cheap compared to its peer companies.
Valuation | Dividend | Operating metrics | ||||||||
▲▼ | Company name▲▼ | Price▲▼ | Change▲▼ | Chg %▲▼ | P/E ratio▲▼ | Price-to- book ratio▲▼ | Mkt Cap▲▼ | Dividend yield▲▼ | Return on avg equity▲▼ | |
MSFT | Microsoft Corporation | 23.91 | -0.47 | -1.93% | 11.36 | 4.58 | 206.91B | 2.62 | 43.76 | |
522.35 | -3.27 | -0.62% | 22.60 | 4.64 | 166.48B | 0.00 | 20.30 | |||
278.64 | -3.88 | -1.37% | 20.98 | 8.03 | 254.56B | 0.00 | 30.54 | |||
26.90 | -0.28 | -1.05% | 21.48 | 4.44 | 135.23B | 0.73 | 21.95 | |||
25.60 | -0.67 | -2.55% | 28.57 | 2.81 | 13.45B | 0.00 | 8.31 | |||
135.25 | -0.39 | -0.29% | 12.79 | 7.82 | 170.59B | 1.92 | 74.37 | |||
5.87 | -0.11 | -1.84% | 2.22 | 2.06B | 0.00 | -21.23 | ||||
14.28 | +0.01 | 0.07% | 23.41 | 1.61 | 19.25B | 0.00 | 5.03 | |||
40.64 | -0.13 | -0.32% | 11.36 | 2.38 | 92.16B | 0.78 | 19.28 | |||
10.05 | -0.26 | -2.52% | 28.40 | 2.14 | 37.64B | 4.73 | 6.53 | |||
15.02 | -0.38 | -2.47% | 15.32 | 2.70 | 11.86B | 0.00 | 16.42 | |||
Discussion:
Headwinds include slowing economic growth which would slow corporate investment in PCs and hence its software.
MSFT has 90% market share of PC market, even with growing Apple and Linux acceptance. MSFT slow growth in the mobile market also is a drag. A fundamental shift in the computing business can also put MSFT behind in the long run, as it becomes a company of the past, but at the current rate of change, this is something that would happen over the next 10 years, given how entrenched corporates are with MSFT products and OS.
MSFT competes in 5 segments, Windows&Windows Live, Server&Tools,Online Services Div, MS Biz Div, Entertainment&Devices. It might be market leader in OS and even in their office suite, but faces stiff competition on all fronts. While it is entrenched today, its market share would face a slow erosion but ultimately reach a steady state.
Unless it comes up with a new breaking technology, PER will remain limited, and EPS would only a slow growth to finally terminal growth rate.
Nonetheless, at current valuations, it is cheap. The personal computing market has room to grow since the poor world still can buy more computers and its associated softwares.
And the business model is intact, with better features, new releases required due to these enhanced features, and the obsolescence of computers every 5 years, it has moved to be a disposable item.
Core earnings would be there, growth would be a tough fight, but MSFT has the financial wherewithal to invest in R&D and has been spending 14% of sales on it and 40% of the staff, which would give it its next step forward as a technology monolith, generating lots of valuable IP.
While the PB is at 4+x, we must recognise that in such a innovative technology company, the BV is not only in the tangible and intangibles but really lies with its people. In comparison to its peers, 4x is not expensive but is comparable, and is not cheap.
MSFT faces macro forces, which determines PC upgrade rates and consumer discretionary spending. But it is also well positioned for strong earnings when the economic recovery is fully underway. Its growth is still mainly driven organically and hence still has legs to run.
Valuations:
MSFT have begun distributing dividends since 2003. It has become a mature company. MSFT reports 1Q11 earnings 28Oct.
EPS_ttm=EPS_10=2.1 [source SNP]
Using DDM: RR is approximately 75%. ROE=28.5 (average over last 10 years)
g=RR*ROE=0.75*28.5=21.39%. This is clearly too large to use for DDM, and hence 3% terminal growth is approximated.
Beta=1.09 [source: SNP]
RFR using USG 10 yr bond yield=2.44 [source Bloomberg]; MRP=5
R_e=RFR+beta*MRP=2.44+1.09*5=7.89
Div_ttm=0.52
FV=0.52*1.03/(0.0789-0.03)=10.95
Examining its sharebuyback, which amounts to roughly 1.2/share. Hence adding that back to div and then applying DDM, FV=36.2. This is only an approximation since the buyback scheme is only funded up to 40B, and hence might not be continued in future. But it does give a good indication that MSFT share value comes primarily in fact from the buyback scheme and its continuation is a good sign. However, there is only about 9B left.
Div yield_ttm=2.3%
BVPS=5.17
PB=4.6x
I prefer to use scenario analysis for MSFT analysis. A fairly conservative assumption is that EPS remains flat, ie EPS_11=EPS_10=2.1
PER_11f will then remain at 11.4x.
If EPS falls by 10%, i.e. EPS_11f=1.89, PER_11f=12.65. Which still keeps it in range of <15. EPS will have to fall to 1.6, i.e. by 24% to hit PER=15. If that happens, the share price would be impacted considerably. Maintaining current PER of 11.4, P=18.24, which is a 23% drop.
Conclusion: TP=31.5, which is EPS_11f=2.1, at PER of 15. This indicates a 31% gain from current P. It is rated a BUY. Once 1Q results release on 28Oct, we would check if earnings are on track. It should be around 0.53 +_0.1. Otherwise the stock price is derailed and might require a sell. Given the downward pressure on the share recently, there is a resistance at 23.4 from its Aug 10 low, and hence close monitoring should be done at that level.
6 Oct 10: MSFT had a 2% rise yesterday, and the PER is now 11.6, P=24.35. Based on the identified TP=31.5, this implies a 29% upside. I would want to buy on weakness tonight for sure, but if it does rise, I need to cap at 25.2 to still ensure a 25% upside.
Buy done at P=24.39 for 410 shares.
Update 29 Oct10: P=27.18, closing up 3%+ on its 1Q report. MSFT reported 1Q performance, diluted EPS_1Q11=0.62. Hence it is on track for a strong FY11 performance. If 2Q performance and macro factors improve, TP can be raised further. Currently maintain TP=31.5.
The div_1Q11=0.16 which is the same as 4Q10. If the same amount is given for next 3Qs, div_11f=0.64, divyield_11f=2.6% at my buy P, and 2.35% at current P which indicates only fair valued. Hence div is expected to rise in 11. PB=4.95x and has deteriorated. MSFT is not a Graham NCA candidate.
8Nov10: Ballmer sells 12% (49m shares and intends to sell up to 75m, or 18%) of his holdings between 26-28$. And Gates recently sold 0.3% (2m shares) of his holdings at 27.23 on average. Looks like I should look to exit also? It is now trading at 26.85.
8Dec10: Continuation buy is up to 28.41 for 351 shares to still have 20% margin.
10Dec10: Bought 367 shares at 27.2. Average P=25.72 and cutloss is at 23.148.
16Jan11: P=28.3.
A long overdue FCF was done, and it indicates that FV using 2010 full year data is 30.89. 2011 data from 1Q shows that it is likely to be an even better year. What is also interesting is that historical price performance also captures the range of 2009 and 2010 FV has been achieved. What is interesting is that MSFT has a huge amount of short term investments on its balance sheet. If they were considered equal to cash equivalents, FV=34.39. [these short term investments amount to 3.5/share] In all fairness, they should be considered on par with cash equivalents. I recommend a review at RP=31.5 in line with the relative valuation analysis with TP=34.39.
28Jan11:
P=28.73
Doing an approximation for FCF based on 1H11 multiplied by2 for CFO and using current balance sheet numbers, FV=32.97.
Diluted EPS_1H11=1.39.
EPS_ttm=1.39+2.1-1.14=2.35
PER_ttm=12.2x
With a 15x target, TP=35.25
Conclusion: I would stick to a TP=32.97, based on FCF which is 14x PER_ttm and upside of 14.75%.
22Feb11:
I am revising FCF analysis to use 30yr USG bond for conservativeness. Revise FV=29.86.
29Apr11
P=26.33
MSFT reported 3q.
EPS_ytd=2.01
EPS_ttm=2.01+0.51=2.52
PER_ttm=10.45x
FCF using some ttm assumptions for CFO and capex, with g=0, RFR=4.7 and MRP=6.5, FV works out to be 33.08, or an upside of 25% or a 13x PER. MSFT continues to look attractively priced.
In terms of market action, MSFT gave up its gains for the day after market which was when the earnings release was done. This sell trend may continue for the day, but MSFT still looks well positioned for gains.
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