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
No comments:
Post a Comment