My recent posted titled, “More Microsoft” generated a significant amount of interest. I was a bit surprised by the number of comments that I’ve received. I appreciate all of them, even the comments that don’t agree with my decision to add more Microsoft (MSFT) stock to my portfolio.

I discussed some of my valuation rationale for the Microsoft purchase decision in the comments section of my previous post. Let me republish it here:

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.

From Magic Formula Investing I found that Microsoft Corp (MSFT), Market Cap of \$248,365.25 (\$ Millions), pre tax earnings yield of 8% and a pre tax return on capital of greater than 100%. Microsoft was in the top 100 MFI stocks with over \$1 billion market cap.

Steven of ValueBlogReview is apparently thinking along a similar line. In his comments regarding “More Microsoft”, Steven wrote:

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.

Another reader, Max, came to a similar finding in regards to valuation. He wrote:

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

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.

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

Jim Chan from Collecting Wealth thinks I jumped the gun on purchasing Microsoft. He writes:

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.

Looking in the rear-view mirror, I think Jim Chan makes a valid point. I don’t normally look at the technicals when buying a position in a stock. However, since reading Phil Town’s Rule #1, I’ve been considering using technical analysis in a very limited way to enter and exit positions. Maybe I should review Phil Town’s “tools” and see how they could have helped me in deciding when to buy Microsoft.

Finally, Chris from InvestorGeeks agrees with my valuation but writes:

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.

In response to Chris’ comment, I don’t think that Mr. Market knows something that we don’t know about Microsoft. I just believe Mr. Market is sort sighted and gets easily depressed when major product release dates are missed. I agree with Mr. Market that Microsoft is going to have tough year, but I believe in the long run they are setting themselves up for some major improvements in the long-term.

I’m sure there are other opinions on whether Microsoft is currently a buy. Please feel free to share your thoughts and analysis either back on the original thread or down below.

7 thoughts on “Comments on “More Microsoft””

• May 5, 2006 at 4:30 pm

Hey George,

I ran the tools real quick (I am not an expert on the Phil Town system but I think I undertsand the tools)

Using your May 1 date of as a buy using the close we see that the tools tell us no way:

http://stockcharts.com/h-sc/ui?s=MSFT&p=D&st=2006-03-05&en=2006-05-01&id=p08928765999&a=76221754

the chart is a two month daily close of MSFT…looks like the tools tell us to get out around 4/10…and while the tolls look like they are saying get in around 4/28 or 5/1…i am learning that the tools are more art than science…(i like having the RSI also)

you see Phil Town says to use 10, 30, or even 50 MA as a trigger point depending on the trend of the stock…so here I see that all three MA’s have convereged 10,30,50 are all about the same..which means the stock has been sideways for sometime and knowing which way it will bounce is kinda hard…so I am not too sure if I would use the tools at this point…

now i personally think the weekly view is the way to go…becuase if you are long term…day to day is not so important…

here is 5 month weekly view…

http://stockcharts.com/h-sc/ui?s=MSFT&p=W&st=2006-01-05&en=2006-05-01&id=p73357280779&a=76221754

now we can see that since 1/30/06 or about there we were told to get out with two reds (Phil Town says in the book three green or reds…but if you read is blog he likes to get out with two reds and in with three because the point is to avoid losing money more thanit is to make money)

and then yo could make the arguemtn that around 3/15/06 that you got a third green arrow on the MACD…but then you got the first red arrow about the same time on the MACD…

and then right about 4/1 you got a second red on the slow stoch…which means you would get out of MSFT at about \$27.25…on the weekly chart…and no three greens have come up since…actually not even one green….

now does that mean you did something worng…no…because with true vlaue you are not looking to time the market…once you have foudn a good deal with a safe MOS..than you buy anf forget and wait for the market to recognize…

but if you want to mix a little TA using Phil Town than yeah you might have waited until there was better momentum…

I think the best thing about Phil Town’s tools is that they realy do help tell a little guy somethign is up…if you take a look at the 2-3 weeks before the most recent buy announment by BRK that it was buying Russell..you can see that the tools headed down…so I think some big players got the whisper what Buffett was up to and got out just in case the market was negative about the purchase…you can run the charts yourself to see what I am talking about…in fact if you go back and pick a stock that disapointed or surprised..and run the tools..you probably will dfind that the tools telegraph the move…

just my own thoughts…like I said i am not an expert…just been sorta playing with it…

Steven

• May 5, 2006 at 4:50 pm

by the way George I think you did okay…

Buffett says MSFT is a buy at \$26….seriously…

remember a joke is is only funny if it is true…lol…and in january when he used it as an example it was trading around 26 1/2…lol…

that does not mean that MSFT is a buy for you or me…just that Buffett/Munger thinks it is a buy for BRK….but imange the bounce MSFT is going to get if it comes out in the 10Q that BRK is buying its first “tech” stock…lol…

• May 6, 2006 at 10:10 am

Steven, I am pretty confident that I did okay by my Microsoft purchase. Thanks for running the charts for me. It’s interesting to note that the “tools” indicate that one shouldn’t have bought MSFT on May 1. I’ll be real interested to see when the “tools” end up indicating an entry point. I’m going to stick to looking at the daily view of these charts, because that is what Phil Town’s experience has lead him to use. However, it is still interesting to see how the weekly charts work out. Have you seen any discussion by Phil regarding weekly charts?

• May 6, 2006 at 1:08 pm

George,

Phil has talked about the weekly view over on his blog…cannot remeber exactly where…if I run across it I will post the link…

Phil essnetially admits that the book is not the end all be all of the Rule # 1 way. The book is essentially writtien to appeal to the widest audience and therefore Phil had to smooth over the nuances. But if click on the link about the indicators you can read the 5-7 posts phil has doen as well as follow up commentary which goes into more detail….

also another thing about the book is that the editors asked him to use “4M” instead of “YUMMMY”…I think YUMMMY was the better more detailed way..but again 4M reads eaiser in the book for most people…you can read about it on th e4M link on the main page..

Sorry did not mean to turn this into a post on Phil Town…..

Glad you liked the charts…I saw Bill R. at nodoodahs.com using stockcharts.com and tried it out…real easy to use…just don’t tell Gannon I am charting..he might ban me form the pure value vclub…lol..

Take care

Steven
on the main page of the blog Yes over on his blog

• May 8, 2006 at 9:55 pm