This is going to be my first of probably 2 or 3 posts on more macro issues, because it seems like a lot of buzz these days is about stuff that's happening macro-economically (i.e. Greek debt crisis, Irish debt crisis, potential US debt crisis, etc.).
I'd like to start off with a fairly simple and relatively short post about "home bias" and why I think it's not really that relevant for a country like the US. If you don't know what "home bias" is, it's basically this theory based on the premise that everyone in the world should be globally diversified in terms of the stocks they own and that the percentage of a person's portfolio that someone has in each country's stock market should be proportionate to that country's market cap as a percentage of world market cap (so, for a few examples, as of June 2008- obviously outdated, but it doesn't really matter for the sake of this example- France is about 4.5% of the world market cap, so according to the theory, everyone should invest 4.5% of their portfolio in French stocks; the US has about 30% of world market cap, so everyone should have 30% of their porfolio in US stocks; Brazil is about 3% of world market cap, so everyone should have about 3% of their portfolio in Brazilian stocks; and so on; Source: http://seekingalpha.com/article/80998-percent-of-world-market-cap-by-country). But the reality is that most people invest the vast majority of their portfolios in their home country (like, for example, even though Germany is only 3.6% of world market cap, probably most of the stock that Germans own is of companies traded on German exchanges). So that's what academics refer to as "home bias"- that most people prefer to invest all or most of their money in stocks in their own country, rather than being globally diversified.
Anyway, basically my thoughts on why it's not really necessary to be globally diversified as an American (and thus why home bias is more or less irrelevant), is because there's so many large US-based corporations that get a significant amount of their revenues from around the world. So, basically, you could argue that you still are globally diversified , indirectly, by owning US companies that have significant international operations. Some really clear examples of this would be GE, Coca-Cola, Pepsico, McDonald's, Procter & Gamble and Johnson & Johnson.
The second, and more important reason to me though, is that if you actually look at most world stock markets, the consumer sector is generally pretty small in most country's stock markets. Like, most world stock markets have the vast majority of their market caps in industries like oil & gas, financials, basic materials (i.e. mining and such), telecommunications and other basically "commodified" industries. And, you may disagree with me, but personally I'm not really interested in investing in those types of industries. Generally speaking, the only significant exceptions to this that I can think of are the US market, major European markets- like the UK, France and Germany- and Japan. But, obviously, all of these other countries do have sizable consumer sectors- it just so happens that a lot of the demand in that sector is supplied by established American, Western European and Japanese companies (at least currently, but obviously that could change in the future). So that's why I think if you live in a country like the US, especially, or possibly a country like the UK, France, Germany or Japan, it actually makes a lot of sense to have a "home bias." Like, I don't really want to invest in an oil company in the US, so why would I want to invest in a Chinese or Brazilian or Russian oil company (aside from probably higher growth prospects, obviously, but that's beside the point in this case, because the reason I wouldn't invest in an oil company is because I don't feel I understand them near well enough and I don't really like the industry as much as I like others)? I don't really want to invest in a US telecom company, so why would I want to invest in a Spanish or Indian or Australian one? I don't want to invest in a US bank, so why would I want to invest in a Chilean or South African or Canadian bank? Not to mention exchange rate risk (although, I guess theorists could argue that if you have a perfectly globally diversified portfolio, any exchange rate changes will offset each other) and political risk.
My main point is that what I want to own, primarily, are branded consumer staple- or at least relatively non-major consumer discretionary, depending on how exactly you want to classify them- companies (i.e. P&G, Coca-Cola, Kraft, General Mills, McDonald's, Nike, etc.), service companies with significant competitive advantages (i.e. ADP payroll processing, Rollins pest control, Moody's bond ratings, etc.) and maybe major diversified industrial conglomerates (i.e. 3M, United Technologies, GE, assuming they get rid of GE Capital, etc.). And it just so happens that most of the companies in those industries are US-based. Although, obviously there are some examples of non-US companies in these industries as well (i.e. Adidas of Germany, Unilever of UK/Netherlands, Siemens of Germany, Nestle of Switzerland, Sapporo Brewery of Japan, etc.), but there's enough offered in the US in this area that I really don't need to go outside of the US. And, at the same time, I guess I would say for citizens of other countries, they should probably have a far higher proportion of their portfolios in American, Western European and Japanese companies than the home bias theory suggests, because those are currently where most of the companies in the best industries are based (although, I won't completely discount the fact that if you live in China, you probably have a far better chance of spotting the rise of a successful Chinese soft drink or chain restaurant, etc. on it's way up than someone living on the other side of the world in America).
Anyway, that's just my view. And just in case you can't tell, I obviously don't believe in Modern Portfolio Theory or anything like that either...haha. I basically just believe in investing in the best companies in what I think are the best industries.
As always, feel free to comment or ask a question.
VF
Sunday, June 19, 2011
Friday, May 27, 2011
Should GE spin-off GE Capital?
Should GE spin-off GE Capital? This is an idea I just thought of the other day. After doing a quick Google search though, I realized it was not completely my own original idea, but I still think I can add some value to the discussion in this post. I'm going to try and keep this post shorter than the last one I did about Microsoft, but I may not succeed...haha
Anyway, this is basically my thesis:
1) GE is traditionally an industrial company, so if they get rid of GE Capital, they could pretty much go back to being a pure industrial company again (with the exception of the 49% of NBC Universal that they currently still own).
2) GE Capital is the main thing that has been holding GE stock down for the past 2 or 3 years. If you look at pre-financial crisis trading levels, the company was valued at about $42/share as recently as September 2007 (which works out to a market cap of about $420 billion, since there were about 10 billion shares outstanding at the time). Now the market cap is pretty much exactly half that, at $207 billion.
3) If you look at the segment information in the 2010 GE annual report (page 39), they show revenues and operating earnings by segment for the past 5 years (2006-2010).
When I do the calculations (and retroactively adjust for the fact that they only own 49% of NBC Universal now instead of 100%), it works out that the combined operating revenues and earnings for all GE segments other than GE Capital has averaged about $95.7 billion and $14.8 billion respectively. Then if we adjust the operating earnings for taxes by assuming they pay around 35% of their operating income in taxes (this is a little over-simplified, but I wanted to keep it as short as possible), we can estimate that GE, excluding GE Capital, has averaged about $9.6 billion ($14.8 billion x [1-0.35]) in earnings over the past 5 years. Then if we apply a multiple of 15-20 to that $9.6 billion, we can estimate that GE excluding GE Capital is worth at least about $144-192 billion. So if we assume that that's true, that means that given the current market cap of $207 billion, the market is valuing GE Capital at between $15 and $63 billion vs. before the financial crisis when they were valuing it at at least around $100-150 billion (back when it was regularly generating like $6-8 billion in earnings and GE's total market cap was around $420 billion).
So I think one thing is pretty clear- the GE Capital segment of GE is being undervalued by the market right now (at only like $15-63 billion right now vs. like $100-150 billion back before the financial crisis). So, to my mind, because of that GE as a company is still pretty significantly undervalued compared to where they were pre-crisis (you might be able to argue it is was overvalued at $420 billion, but I'm pretty sure it's worth at least around $350 billion, based on the fact that they were making like $20 billion/yr before the crisis).
Now here's why I specifically think they should spinoff GE Capital:
1) GE (excluding GE Capital) is possibly worth even more than $144-192 billion, because pretty much all of the other industries that GE is in are growing industries (like healthcare equipment, renewable energy equipment, etc.), so I wouldn't be surprised if it's even worth like $250 billion or more just by itself. But it's a lot less likely that the market is ever going to recognize that if it's muddled up by all of the GE Capital stuff.
2) It would be a lot more likely that GE shareholders could get their value back out of GE Capital sooner, because with GE Capital as a separate business, it would likely be easier for the market to evaluate how much GE Capital is actually worth.
3) I can't find anything in the annual report specifically breaking down how much of the debt is from GE Capital and how much is from the rest of GE's operations, but if you look at comparable industrial companies (like Siemens, United Technologies, Honeywell, etc.) their debt loads are way lower. So I'm pretty sure the vast majority of the ~$300 billion in debt that GE currently has is related to GE Capital. Thus, if they could spin off GE Capital, they could get rid of a lot of that debt.
Anyway, in conclusion, I personally would not want to own GE as it currently is right now, because I'm really weary of financials right now in the wake of the financial crisis (and if I did want to invest in a financial company, I would most likely just invest in a pure bank, rather than having it mixed in with industrials). But if GE ever actually takes mine and others advice and spins off GE Capital, I think there's a pretty bright future still ahead for GE. They're in a lot of good, decently growing industrial businesses, and I just think it's time for them to shed the financial side of their business. If they can, I really think that GE could be a great long-term hold.
The benefit of spinning off GE Capital rather than selling it is that they don't have to worry about finding a specific buyer and also they're not short-changing current shareholders by selling GE Capital for cheap when it's down, because they'd be giving the company to the shareholders and just giving them the option of either selling or waiting for the recovery. Some shareholders will hold onto GE Capital until it fully recovers and others will take the option of selling the financial exposure and just holding on to the core industrial company that will be left after the spinoff.
Let me know if you agree or disagree with my reasoning.
VF
Anyway, this is basically my thesis:
1) GE is traditionally an industrial company, so if they get rid of GE Capital, they could pretty much go back to being a pure industrial company again (with the exception of the 49% of NBC Universal that they currently still own).
2) GE Capital is the main thing that has been holding GE stock down for the past 2 or 3 years. If you look at pre-financial crisis trading levels, the company was valued at about $42/share as recently as September 2007 (which works out to a market cap of about $420 billion, since there were about 10 billion shares outstanding at the time). Now the market cap is pretty much exactly half that, at $207 billion.
3) If you look at the segment information in the 2010 GE annual report (page 39), they show revenues and operating earnings by segment for the past 5 years (2006-2010).
When I do the calculations (and retroactively adjust for the fact that they only own 49% of NBC Universal now instead of 100%), it works out that the combined operating revenues and earnings for all GE segments other than GE Capital has averaged about $95.7 billion and $14.8 billion respectively. Then if we adjust the operating earnings for taxes by assuming they pay around 35% of their operating income in taxes (this is a little over-simplified, but I wanted to keep it as short as possible), we can estimate that GE, excluding GE Capital, has averaged about $9.6 billion ($14.8 billion x [1-0.35]) in earnings over the past 5 years. Then if we apply a multiple of 15-20 to that $9.6 billion, we can estimate that GE excluding GE Capital is worth at least about $144-192 billion. So if we assume that that's true, that means that given the current market cap of $207 billion, the market is valuing GE Capital at between $15 and $63 billion vs. before the financial crisis when they were valuing it at at least around $100-150 billion (back when it was regularly generating like $6-8 billion in earnings and GE's total market cap was around $420 billion).
So I think one thing is pretty clear- the GE Capital segment of GE is being undervalued by the market right now (at only like $15-63 billion right now vs. like $100-150 billion back before the financial crisis). So, to my mind, because of that GE as a company is still pretty significantly undervalued compared to where they were pre-crisis (you might be able to argue it is was overvalued at $420 billion, but I'm pretty sure it's worth at least around $350 billion, based on the fact that they were making like $20 billion/yr before the crisis).
Now here's why I specifically think they should spinoff GE Capital:
1) GE (excluding GE Capital) is possibly worth even more than $144-192 billion, because pretty much all of the other industries that GE is in are growing industries (like healthcare equipment, renewable energy equipment, etc.), so I wouldn't be surprised if it's even worth like $250 billion or more just by itself. But it's a lot less likely that the market is ever going to recognize that if it's muddled up by all of the GE Capital stuff.
2) It would be a lot more likely that GE shareholders could get their value back out of GE Capital sooner, because with GE Capital as a separate business, it would likely be easier for the market to evaluate how much GE Capital is actually worth.
3) I can't find anything in the annual report specifically breaking down how much of the debt is from GE Capital and how much is from the rest of GE's operations, but if you look at comparable industrial companies (like Siemens, United Technologies, Honeywell, etc.) their debt loads are way lower. So I'm pretty sure the vast majority of the ~$300 billion in debt that GE currently has is related to GE Capital. Thus, if they could spin off GE Capital, they could get rid of a lot of that debt.
Anyway, in conclusion, I personally would not want to own GE as it currently is right now, because I'm really weary of financials right now in the wake of the financial crisis (and if I did want to invest in a financial company, I would most likely just invest in a pure bank, rather than having it mixed in with industrials). But if GE ever actually takes mine and others advice and spins off GE Capital, I think there's a pretty bright future still ahead for GE. They're in a lot of good, decently growing industrial businesses, and I just think it's time for them to shed the financial side of their business. If they can, I really think that GE could be a great long-term hold.
The benefit of spinning off GE Capital rather than selling it is that they don't have to worry about finding a specific buyer and also they're not short-changing current shareholders by selling GE Capital for cheap when it's down, because they'd be giving the company to the shareholders and just giving them the option of either selling or waiting for the recovery. Some shareholders will hold onto GE Capital until it fully recovers and others will take the option of selling the financial exposure and just holding on to the core industrial company that will be left after the spinoff.
Let me know if you agree or disagree with my reasoning.
VF
Monday, May 16, 2011
Microsoft: a value tech stock?
I've been looking at Microsoft for a few years now. I'm not really a big tech investor myself, because it seems really competitive and products seem to become obsolete really quickly. But Microsoft seems to be kind of an exception. This was their revenue breakdown for 2010 (according to the Value Line Investment Survey):
Microsoft Business, 29.8% of total; Windows & Windows Live, 29.6%; Server and Tools, 23.8%; Entertainment & Devices, 12.9%; Online Services, 3.5%; Other, .4%
Microsoft Business is basically Microsoft Office, which is a virtual monopoly. Windows and Windows Live are self-explanatory. Servers and Tools is a little more ambiguous- I had to look up exactly what that was, and am still not 100% sure what it is (again, I'm not really a tech guy...haha), but I got a decent idea, and apparently they are one of the market leaders just as they are in Office and Operating Systems. Entertainment and Devices is basically X-Box and it's games, computer games, Zune mp3 players, software related to cell phones (Windows Phone 7, etc.) and small hardware like keyboards and mice. Online Services is MSN and Bing. "Other" is just a miscellaneous category that they throw a bunch of minor stuff that doesn't fit into any other category, I think. Anyway, this might not all be technically correct, but I'm just trying to give a general overview of everything that the company does so that I can discuss what portion of their business they most likely have a durable competitive advantage in.
In my view, Microsoft Office (Microsoft Business) and Windows and Windows Live have durable competitive advantages. Entertainment and Devices is also probably safe (XBox basically operates in an oligopoly market along with Sony and Nintendo and the other products from this category can probably at least hold their current position in their markets, even if they may not be dominant players). Online services (Bing & MSN can probably at least maintain their current position in the market, even though Google is the clear leader and Yahoo is probably #2) and "Other" seems safe as well (but even if it isn't, it's such a small part of the company that it probably doesn't really matter that much). So I personally am confident that at least 76.2% of the their revenues are definitely safe and can at least grow modestly going forward. The only part that I'm not 100% sure about is the Servers & Tools division because, like I said, I'm not really sure exactly what they do. But they do seem to have some reasonably recognizable names and cover a lot of areas (Microsoft Server 2008 R2, Microsoft Visual Studio, Microsoft Silverlight, Systems Management Server, Microsoft SQL Server, Microsoft Exchange Server, Small Business Server, Microsoft BizTalk Server). So I am fairly confident that they are a major player in that area and that it is reasonably sustainable. And then there of course is this pending $8.5 billion Skype deal.
Going with that logic, I will continue to try and value Microsoft based on a few different scenarios. But first, I will give a few summarizing figures to show how profitable and safe of a company Microsoft is (I'll be mainly using figures from the latest Value Line report, for convenience).
Over the past 10 years, MSFT's return on equity and capital has varied between 15% and 48%, but on average has been well above 20%. Sales, earnings and cash flow per share has grown by over 10%, on average for the past 10 year period and 5 year period. The only real concern is that they have started to go into some debt over the past few years, but it is still easily manageable.
When I refer to their financial statements for the past 5 years (found here, if you would like to reference them yourself: http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?lstStatement=CashFlow&symbol=US%3aMSFT&stmtView=Ann), I find that they have averaged about $2/share ($16.9 billion/8.43 billion shares outstanding) in free cash flow (I just used the formula: free cash flow = operating cash flow - capital expenditures, to keep it simple).
Now one way that I use to value companies, basically the most simple way, is to use the roughly long-term risk-free government bond rate of 6% (you can use your own estimate though, like 5% or 7% or whatever, but it's around 6%) and then find out what price I could buy the company at and get a 6% yield. So, with Microsoft, if we take the $2/share in free cash flow and divide by 6%, we get about $33/share (or, if we use a 25% margin of safety, then it's about $26/share). But the thing you have to remember is that this valuation model basically assumes no growth (like, basically, it just assumes that Microsoft will make around $2/share every year indefinitely, or at least for many years to come, which is easily believable if you agree with what I said in the beginning of the article about the durability of their business divisions).
Now let's consider if Microsoft can actually grow modestly for at least the next 10 years. With a 5% growth rate for the next 10 years, Microsoft's free cash flow will have grown from $2/share to about $3.26/share. Then if we apply my simple valuation model (the price that gives a 6% yield), we find that Microsoft would be worth about $54/share in 10 years, so if we desire a 10% compounded return over those 10 years, we would need to buy at about $21/share (which is only about $3-4 less than what MSFT is selling for, as of May 16th, 2011)- also, this does not take into account the 2.5% dividend yield that Microsoft currently has. Or, alternatively, we could do a slightly more sophisticated model and actually discount all future cash flows today to find the present value. In that case, we could argue that Microsoft is worth about $49/share right now. Assuming that the $49/share number is correct, we could buy the stock today and if it goes up to it's fair value within the next 2-5 years, we could make a 14-40% compounded return (depending on whether it takes 2 years or 5 years or somewhere in between), plus dividends by buying it for ~$25 today.
Now let's be a little more optimistic and assume that Microsoft can grow by 8%, on average, for the next 10 years (a little better than 5%, but not quite as good as the 10%+ that they've been doing for the past 5-10 years). That would mean that their free cash flow per share will have grown to about $4.32/share in 10 years, which means the stock should be worth about $72/share in 10 years, so if you bought today at $25/share, you would earn an 11% compounded return plus dividends. Or if we use a present value of future cash flows approach, the company would be worth about $62 today, which means if we bought today at ~$25 and it returns to fair value within 2-5 years, we could earn a 20-57% compounded return.
So, basically my logic is that if you buy today, even if MSFT pretty much just holds it's own and doesn't grow at all (which is unlikely, because they'll likely grow at least a little going forward), you at least won't lose any money by buying at the current price. If it grows at a modest rate (like 5%, which would be pretty easily attainable, if you include the growth effects of inflation, general economic and population growth and share repurchases which increase per share values) you can make an 8%+ return by holding longer-term or a 14-40% return by doing more of a mid-term trade. Or, if we're a little more optimistic, you can make an 11% return long-term or potentially make a 20-57% return by doing a more mid-term trade. Personally, I'm generally most intrigued by mid-term trading prospects (2-5 years), because it seems like it's a lot easier to get high returns by taking advantage of temporary price inefficiencies than to try and invest long-term (where reversion to the mean is much more of an issue). Of course, if you were really "bullish" on Microsoft's future growth prospects and thought that they could grow by like 10-15% or more over the next 5-10 years, then it could be really lucrative to buy and hold for the long-term.
But I am also interested in investing long-term; it's just that I find you have to find companies with higher growth rates that are a lot more undervalued in order to hold for the really long-term and still get really good returns (like Buffett has with companies like Coca-Cola, American Express, Wells Fargo and Gillette/P&G). Like, I would almost always prefer to just buy a stock and own it forever, but not if I have to pass up 20-30% returns on mid-term trades in favor of 10% returns on longer-term trades. However, I think every portfolio has to have a good core of blue chip stocks, as long as you make sure you only pay reasonable prices for them.
Anyways, that's everything I have to say about that. I probably could've gone a lot more in-depth, but this seems like it has been enough writing for me and reading for you...haha. But feel free to comment if you have any questions and I'll be sure to respond. I just really think a lot of people are overlooking Microsoft (and have been for several years now) and I'd really like to see that value get redeemed. I personally don't think I will buy any, just because I'm more into traditional industries (i.e. household goods, soft drinks, branded foods, restaurants, retail, etc.), but in terms of technology stocks, I think Microsoft is kind of an overlooked value stock. Judge for yourselves though, and if you think what I'm saying has some merit, go ahead and buy and hopefully you can make a lot of money ;)
VF
Microsoft Business, 29.8% of total; Windows & Windows Live, 29.6%; Server and Tools, 23.8%; Entertainment & Devices, 12.9%; Online Services, 3.5%; Other, .4%
Microsoft Business is basically Microsoft Office, which is a virtual monopoly. Windows and Windows Live are self-explanatory. Servers and Tools is a little more ambiguous- I had to look up exactly what that was, and am still not 100% sure what it is (again, I'm not really a tech guy...haha), but I got a decent idea, and apparently they are one of the market leaders just as they are in Office and Operating Systems. Entertainment and Devices is basically X-Box and it's games, computer games, Zune mp3 players, software related to cell phones (Windows Phone 7, etc.) and small hardware like keyboards and mice. Online Services is MSN and Bing. "Other" is just a miscellaneous category that they throw a bunch of minor stuff that doesn't fit into any other category, I think. Anyway, this might not all be technically correct, but I'm just trying to give a general overview of everything that the company does so that I can discuss what portion of their business they most likely have a durable competitive advantage in.
In my view, Microsoft Office (Microsoft Business) and Windows and Windows Live have durable competitive advantages. Entertainment and Devices is also probably safe (XBox basically operates in an oligopoly market along with Sony and Nintendo and the other products from this category can probably at least hold their current position in their markets, even if they may not be dominant players). Online services (Bing & MSN can probably at least maintain their current position in the market, even though Google is the clear leader and Yahoo is probably #2) and "Other" seems safe as well (but even if it isn't, it's such a small part of the company that it probably doesn't really matter that much). So I personally am confident that at least 76.2% of the their revenues are definitely safe and can at least grow modestly going forward. The only part that I'm not 100% sure about is the Servers & Tools division because, like I said, I'm not really sure exactly what they do. But they do seem to have some reasonably recognizable names and cover a lot of areas (Microsoft Server 2008 R2, Microsoft Visual Studio, Microsoft Silverlight, Systems Management Server, Microsoft SQL Server, Microsoft Exchange Server, Small Business Server, Microsoft BizTalk Server). So I am fairly confident that they are a major player in that area and that it is reasonably sustainable. And then there of course is this pending $8.5 billion Skype deal.
Going with that logic, I will continue to try and value Microsoft based on a few different scenarios. But first, I will give a few summarizing figures to show how profitable and safe of a company Microsoft is (I'll be mainly using figures from the latest Value Line report, for convenience).
Over the past 10 years, MSFT's return on equity and capital has varied between 15% and 48%, but on average has been well above 20%. Sales, earnings and cash flow per share has grown by over 10%, on average for the past 10 year period and 5 year period. The only real concern is that they have started to go into some debt over the past few years, but it is still easily manageable.
When I refer to their financial statements for the past 5 years (found here, if you would like to reference them yourself: http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?lstStatement=CashFlow&symbol=US%3aMSFT&stmtView=Ann), I find that they have averaged about $2/share ($16.9 billion/8.43 billion shares outstanding) in free cash flow (I just used the formula: free cash flow = operating cash flow - capital expenditures, to keep it simple).
Now one way that I use to value companies, basically the most simple way, is to use the roughly long-term risk-free government bond rate of 6% (you can use your own estimate though, like 5% or 7% or whatever, but it's around 6%) and then find out what price I could buy the company at and get a 6% yield. So, with Microsoft, if we take the $2/share in free cash flow and divide by 6%, we get about $33/share (or, if we use a 25% margin of safety, then it's about $26/share). But the thing you have to remember is that this valuation model basically assumes no growth (like, basically, it just assumes that Microsoft will make around $2/share every year indefinitely, or at least for many years to come, which is easily believable if you agree with what I said in the beginning of the article about the durability of their business divisions).
Now let's consider if Microsoft can actually grow modestly for at least the next 10 years. With a 5% growth rate for the next 10 years, Microsoft's free cash flow will have grown from $2/share to about $3.26/share. Then if we apply my simple valuation model (the price that gives a 6% yield), we find that Microsoft would be worth about $54/share in 10 years, so if we desire a 10% compounded return over those 10 years, we would need to buy at about $21/share (which is only about $3-4 less than what MSFT is selling for, as of May 16th, 2011)- also, this does not take into account the 2.5% dividend yield that Microsoft currently has. Or, alternatively, we could do a slightly more sophisticated model and actually discount all future cash flows today to find the present value. In that case, we could argue that Microsoft is worth about $49/share right now. Assuming that the $49/share number is correct, we could buy the stock today and if it goes up to it's fair value within the next 2-5 years, we could make a 14-40% compounded return (depending on whether it takes 2 years or 5 years or somewhere in between), plus dividends by buying it for ~$25 today.
Now let's be a little more optimistic and assume that Microsoft can grow by 8%, on average, for the next 10 years (a little better than 5%, but not quite as good as the 10%+ that they've been doing for the past 5-10 years). That would mean that their free cash flow per share will have grown to about $4.32/share in 10 years, which means the stock should be worth about $72/share in 10 years, so if you bought today at $25/share, you would earn an 11% compounded return plus dividends. Or if we use a present value of future cash flows approach, the company would be worth about $62 today, which means if we bought today at ~$25 and it returns to fair value within 2-5 years, we could earn a 20-57% compounded return.
So, basically my logic is that if you buy today, even if MSFT pretty much just holds it's own and doesn't grow at all (which is unlikely, because they'll likely grow at least a little going forward), you at least won't lose any money by buying at the current price. If it grows at a modest rate (like 5%, which would be pretty easily attainable, if you include the growth effects of inflation, general economic and population growth and share repurchases which increase per share values) you can make an 8%+ return by holding longer-term or a 14-40% return by doing more of a mid-term trade. Or, if we're a little more optimistic, you can make an 11% return long-term or potentially make a 20-57% return by doing a more mid-term trade. Personally, I'm generally most intrigued by mid-term trading prospects (2-5 years), because it seems like it's a lot easier to get high returns by taking advantage of temporary price inefficiencies than to try and invest long-term (where reversion to the mean is much more of an issue). Of course, if you were really "bullish" on Microsoft's future growth prospects and thought that they could grow by like 10-15% or more over the next 5-10 years, then it could be really lucrative to buy and hold for the long-term.
But I am also interested in investing long-term; it's just that I find you have to find companies with higher growth rates that are a lot more undervalued in order to hold for the really long-term and still get really good returns (like Buffett has with companies like Coca-Cola, American Express, Wells Fargo and Gillette/P&G). Like, I would almost always prefer to just buy a stock and own it forever, but not if I have to pass up 20-30% returns on mid-term trades in favor of 10% returns on longer-term trades. However, I think every portfolio has to have a good core of blue chip stocks, as long as you make sure you only pay reasonable prices for them.
Anyways, that's everything I have to say about that. I probably could've gone a lot more in-depth, but this seems like it has been enough writing for me and reading for you...haha. But feel free to comment if you have any questions and I'll be sure to respond. I just really think a lot of people are overlooking Microsoft (and have been for several years now) and I'd really like to see that value get redeemed. I personally don't think I will buy any, just because I'm more into traditional industries (i.e. household goods, soft drinks, branded foods, restaurants, retail, etc.), but in terms of technology stocks, I think Microsoft is kind of an overlooked value stock. Judge for yourselves though, and if you think what I'm saying has some merit, go ahead and buy and hopefully you can make a lot of money ;)
VF
Thursday, February 3, 2011
First Post
I'm not ready to make a substantive post yet, but I just figured I'd basically outline the point of this blog...
About 7 years ago, I started studying famous value investors like Benjamin Graham and Warren Buffett. I have also read other books about investing, but I identify most with the Buffett strategy of value investing and have also been influenced a little by Joel Greenblatt. On this blog, I hope to discuss companies as potential investments, from that perspective.
I hope you'll come back and be a regular reader once I get started.
VF
About 7 years ago, I started studying famous value investors like Benjamin Graham and Warren Buffett. I have also read other books about investing, but I identify most with the Buffett strategy of value investing and have also been influenced a little by Joel Greenblatt. On this blog, I hope to discuss companies as potential investments, from that perspective.
I hope you'll come back and be a regular reader once I get started.
VF
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