# More Microsoft

I couldn’t resist the prices Mr. Market was offering for Microsoft (MSFT) today. Last Friday Microsoft’s stock took a beating. Shares where down over 11 percent. The company lost more than $32 billion dollars in market capitalization. All this as a result of Microsoft missing profit expectations. Given the delays with Vista and Xbox problems, I wasn’t too surprised. However, Mr. Market flipped out.

I took advantage of the opportunity. I put in a limit order earlier this morning for $24.25 a share in one of my accounts and with Marketocracy. I received the following confirmation from Marketocracy:

Your ticket to buy 4120 shares of MSFT at $24.2500, created at 13:27 May 01 completed at 15:45 May 01. 4120 shares were bought at a net average price of $24.2994 including commissions and fees.

I reran my intrinsic value spreadsheet for Microsoft this morning, and I still get at least $30 per share in value. Given that finding, I decided to pull the trigger and add to my Microsoft position. I don’t normally buy a stock a second time, but I just couldn’t pass up buying some more of the widest moat stock at a discount.

Hey George,

I am thinking along similar lines…but one thing that has given me pause is the sheer size of the float. I read an article the otherday that pointed out what it means when MSFT goes up (or down). If MSFT goes up a $.01 that adds about 92 million to the market cap (.01 x 10 bill)

if it goes up a buck it adds 9.2 bill.. the sheer numbers alone give me pause…

but i dont think MSFT is a no growth stock and the current valaution puts it at growing at about 2% which I think it will beat over the next decade (I mean if you think MSFT is gonna grow at even 6%, which is what it did the last 5 years, you can make the case for a price of 34.50 per common)

Even assuming growth of 10-11% (which I would give a50-50 chance) you get to just about a 45% MOS with the stock at $24.50.

I have been looking at MSFT myself and ran the numbers. Maybe I am way off but where are you getting your valuations. I have been using a 10% growth number and I still can get much beyond 28 per share. I just don’t understand the discrepancy.

I guess it all depends on what metrics you are using (eps, cf, bv, s) per share…it also depends on what discount rate you are using…me I go with what Buffett says..use the best risk free rate (10 year bond or AAA corp) but no lower than 6%…(you dont adjust the disocunt rate based on the company you adjust based on the risk as it applies to the company when figuring out growth estimates)…I also assume 0% growth past year 10…

then ask yourself this quesiton: how sure are you that XXX can grow by XXX. and reduce by lack of confidence.

using EPS ttm per share as the measure…(i am using the figures from yahoo)

for me I think MSFT can at least maintain its eps over the next 10 years (i.e. 0% growth) well that means a fair price would be $19.97.

can it grow by 1% = 22.39 per share

how about 2%—do you have 100% confidence that MSFT can grow by at least 2% per year for the next 10?

well that gets you to $24.80 as a fair price..and today it is trading at $24.06 as I write…..

so if you read my blog you know where I am coming from…my goal is not to lose money…

so if I buy MSFT at $24.06…and all it does is grow at 2% a year…than I have met my goal…

now of course I want to actually increase my money through compounding….so whther MSFT can do that for me is another matter…

if MSFT grows by 6%…$34.49 per share

8% ….39.33

obviosuly though the higher the growth number the less confidence I have…so the greater MOS I might require (but clearly if 8% growth is reasonable than MSFT is at about a 40% MOS or about a 66% MOS if you define it as the amount which the shre priece must rise to get to fair value 16/24)

for me the first quesiton I ask is what are the chances I will lose money with XXX compared to a risk free bond….and I think I wont lose any money buying MSFT at $24 cuz I beleive it can grow at 2% (but that is just a thought…I have no done any hard core analysis of the fundamentals..I am just speaking in the abstract in repsonse to the quesiton regarding a DCF analysis)

doing the DCF analysis to get a fair value is not really that hard…I mean I have only been investing for 5 months and I can do it in my head in a few minutes…

the real hard part is not figuring out what the fair price of something is today..guess all anyone is doing is guessing about the future using whatever number sthey want…even Buffett is guessing…what something is going to be worth 10 years from now…

the hard part I have not figured out is how to figure out how to make your guess more than likely to come true…

and thats why Buffett has what he has..and I dont…lol…he has figured out a way to narrow done the possible outcomes in order to make his forecast more likely than not…and than he acts on it…

again I might be all wrong but I offer my thoughts for consideration…

Steven

I haven’t done any thorough analysis or anything, but just by looking at the financial statements and running some back-of-the-envelope calculations, here is what I come up with:

I assume $14B in EBIT and FCF (normalized)

Enterprise Value = $213B

So, trading at about 15.2x EBIT (or FCF)

Even though I’m not a huge fan of only comparing to other companies for valuation, I will do so just for simplicity. AAPL is trading at 28x (but with more growth), ORCL @ 18x, MFE @ 14x, NOVL @ 22x, ERTS @ 20x, and GOOG I don’t want to comment on.

Microsoft as a huge moat, but not too much growth, so I’m going to put it at 20x EBIT, which for a DCF calculation means I am assuming a 10% RROR and 5% growth in perpetuity.

Enterprise Value = 20 * 14B = $280B

$280B + $34B (cash) = $314B

$314B / 10.33B outstanding = $30.4 / share

Looks like Steven beat me to it. Steven, it looks like you came up with about the same numbers using EPS and a DCF model. I like using the EV/EBIT model whenever I can, but that’s just because its easier for me. I agree that at minimum MSFT is worth what it’s selling for today, as no matter what calculations I do the lowest # I come up with is around today’s price. So, that’s some downside protection, plus MSFT’s current moat on operating systems keeps that cash coming in.

Max

I agree with you on EBIT and EV…my point is just trying to illustrate what Buffett says about it just jumping oput at you on the page as you read…..obviously if you can eyeball it using EPS or FCFS or anything else..than getting into the numbers using EV/EBIT, ROIC, etc, is the way to go.

I guess my point as someone new to all this is that developing a quick way to do a DCF whre you can get a quick guesstimate in your head in a few minutes or less is a quick way to “screen” for possible companies worth looking into…

that was the poitn of the part of my post where I talked about the sheer size of MSFt float…for every $ MSFT goes up per common another 9 or so billion gets added to market cap…every $10 is another 90-100 billion…

when you think of it that way…it tempers against MSFT being a “growth” stock with repsect to double digits…i mean for MSFT to double means the market cap goes to half a trillion…which makes you think more honestly about projections…especially when you wright it out $500,000,000.00…

so I look at MSFt as a defensive value stock with some upside growth potential…(i think of it as a value play with some growth as opposed to a growth play with some value) much the same way I look at BRK…or BUD..or KO…find a company which is providing a decent value with built safety when compared to a long bond..with some upside on the growth side…that is part of the account..once I get more skill in all this I will start looking for the growth/value as opposed to value/growth.

Steven

Wow, great conversation on Microsoft everyone. Let me tell you about my intrinsic value estimate.

I took a linear regression (i.e., a fancy way of drawing a line on a graph) of the past 10 years of Microsoft’s free cash flow. I then used that regression to project the next 11 years of free cash flow. The regression was able to explain 90 percent of the past trend in the data. I then took the present value of the first 10 years into the future and the discounted perpetual value of the 11th years estimated free cash flow estimated to maintain a sustainable growth of 3%. I selected a 10 percent discount rate for the calculations. I then added in cash to get the intrinsic enterprise value of Microsoft and then I divided by the diluted average number of shares. My final result was $31 dollars per share.

I almost forgot the Magic Formula Numbers I got today:

Microsoft Corp (MSFT), Market Cap=248,365.25, EY=8% ROC > 100%, Prices from 05/01 03/31

Microsoft was in the top 100 MFI stocks with over $1 billion market cap.

What you have here is an investment with all themarket risk and a very limited reward. You might make some money here, you might lose some.

If you want low risk, buy a CD.

If you want to invest , find something with some mojo.

Obviously the boyz of the street have no use for the ‘metrics’ you are running here, and you may be waiting for Godot.

Hmmmm. looks like you get to average down.

Its a lot easier arbing 99 shares than trying to game 4000 shares of a bloated cow.

>>>you may be waiting for Godot>Obviously the boyz of the street have no use for the ‘metrics’ you are running here>Its a lot easier arbing 99 shares than trying to game 4000 shares of a bloated cow.

While I don’t think MSFT is a bad investment opportunity (not a particularly exciting one for me, even at this level), I think you might have jumped in a little early. Purely technical (read, short term) prospect calls for a further decline. At the very least, you probably should’ve waited till the volume has subsided. Back to the “not so exciting” part, before the slide, my calculation (there seems to be quite a few Buffett followers read your blog) showed it was trading at fair value. So the drop represents the discount that (30%) you can Steve and other have discussed. To me, that margin is still too shallow. The flip side of the scale, from the qualitative side of spectrum, I am not quite sure Balmer is the right guy to lead MSFT. Again, not so terribly excited about MSFT, but doesn’t mean it’s not a good investment. Just not good enough for me.

Steven,

I’m a little curious about your Intrinsic Value calculations. You say that you start out with assuming the company has 0% growth so therefore you start at $19. I follow your argument afterwards, but I’m a little dubious of your starting point of $19.

A company that doesn’t grow is actually shrinking by about 2% annually because of inflation, and your valuation of $19 puts the PE ratio to about 15. I don’t know about you, but I wouldn’t pay a PE of 15 for ANY company shrinking by 2% a year. In any case, I think that’s a very generous starting point. My sticker is about $31, which gives me a MOS of 30%, however, given that the stock has traded between $24 and $29 for the last 3 years, I’m thinking the market knows something I don’t, which furthur hurts my MOS.

If you have the time to do the research, I think this is too risky for the potential reward. I posted an article last night with my thoughts at my site, InvestorGeeks:

http://www.investorgeeks.com/articles/2006/05/04/microsoft-is-now-the-time-to-buy/

Chris

you are correct about inflation…but it applies to all metrics…if you think MSFT grows 10% over the next 5 or 10…is that not really 8% after inflation…so inflaiton..whether it is 2,4,6 or 10 is alsways going to affect any growth projection…and we dont know before hand what inflation is going to be..so how do we account for it?…we can average for it…but we can average for anything…I am just tryign to keep a DCF as simple as possible…

and when I compare investments I compare them as a relative decision…not against inflaiton but against each other

should I buy MSFT at 8% growth or GOOG at 21% (or if should I adjust for 2% inflation and say 6 and 19??? but what if inflation is rerally 8%…or or or or) (thats why I use 0 as my terminal value aftyer year 10)

but that was not the point of my post…

my point was merely to demonstrate that in doing a DCF removing the fog of optimistic assumtpions is the way I like to proceed…with as few variables as possible…

so I start with a 0% quesiton (and if it helps that assumes 0% after inflation..because I cant know what inflation will be but I know it will apply to all companies)

so the quesiton is…can MSFT (or any company I look at) at least mainatin its earnings over the next 10 years…or to put it another way..how sure am I that MSFT (or XYZ corp) be in business in 10 years at its current rate of earnings?

(now obviosuly a comapny over the next 10 years can earn a negative return…but I would hope my fundamnetla analysis would weed those companies out before I get tot he DCF…lol)

because if I cant answer that I think MSFt or any company is gonna at least be able to maintain its poisiton…what business do I have in investing in it…

anyway back to the DCF…so if MSFt can maintain its earnings (as a relative quesiton) than at 0% growth whats it worth…well a zero percent growth stock at 1.26 ttm eps (not that I think that is the best metric just the quickest for this purpose) is worth 16.5 p/e (actually 16.66 but it makes calacualting in my head to round easier to round…this is assuming a 6% discount rate…)

so 16.5 times 1.26 (round to 1.25 to make it easier) is just about $20.50…(if you dont round it is $20.99 16.66 x 1.26…)…

in order to justify MSFT current price as a buy with a MOS of 50% (23.80 x 2 = $47.60) than microsoft has to grow at about 10.5% per annum over the next 10 years….to put it another way the fair p/e is 37.50…

and how sure are you of that?

because in order for MSFT to be a buy today you have to be 100% sure that it will grow at a 10.5% clip for the next

thats why I statrt at zero and work my way up until I get to a point where I dont have 100% confidnece in the growth number…

me I think just off the top of my head base don its size and other stuff..MSFt can maintian 5-8% over the next 10…so that gives me $31-39 as a fair vlaue today…

slap a 50% MOS and I get a $16-19 buy target..actually because of its position I might only require the 30% MOS and use 6% and you got a buy at $23.52…hey what do you know…lol

anway i think the DCF is the easy part of the problem…figuring out the business of MSFT 10 years from now is the hard part…

Gotcha. So inflation is assumed.

I guess my real question was with your 16.5 P/E at 0% growth. I understand the rest of your calculation, but why do you assume that 16.5 times earnings is an appropriate price for a 0% growth company? It seems awfully expensive.

I’m going to have to read more about Discounted Cash Flow (DCF) analysis and get back to you.

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Chris,

I dont assume it, the DCF just tells me thats what it is worth. I really dont undertand the math ( I mean I do undertsand it I just cant explain it quickly Bill at nodoodahs.com can though)

Take a $1.00 of eanrings, discount it at 6% for 10 years at 0% terminal growth of 0%, and the fair value of the stock will be $16.67 (like I said I round down to make a quick fugure in my head easier)

Take 2.00 and it will be 33 (actually 33.33 but I round)..

the formula is set forth in Graham’s II…the DCf is really that simple..not easy but simple…Graham’s genius is really amazing..not becase of it..but because he could take something which might at first appear complicated yet set forth a way of making it so simple…

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