Microsoft: The greatest stock in the world?
Opdateret: 7. aug.
Some refer to Microsoft as the greatest stock in the world. I understand why some refer to Microsoft that way, as it is one of only two companies with an AAA credit rating (the other being Johnson & Johnson). Microsoft has delivered tremendous growth over the years, and their products are expected to be in demand for years to come. The question is, is now the time to buy the stock? In this analysis, I will attempt to answer that question.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do own Microsoft stocks. Microsoft currently represents 2,57% of my copy trading portfolio. If you would like to copy the portfolio or view the stocks I hold, you can find instructions on how to do so here. I see Microsoft as a compounding investment, and I don't expect to close the position any time soon. Despite being the owner of Microsoft, I will ensure that this analysis remains unbiased. If you want to buy shares or fractional shares in Microsoft, you can do so through eToro.
Microsoft is a multinational technology company based in the United States. I do not want to go into too much detailabout the company, as I assume that everyone is already familiar with it. However, one should be aware of the variousbusiness segments of the company. Microsoft operates and reports its financial performance using the following business segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. In short, theProductivity and Business Processes division includes Office 365, LinkedIn, and cloud-based applications. Intelligent Cloud includes Azure, as well as support and consulting services. More Personal Computing includes Windows, devices, gaming, and search advertising. Regarding Microsoft's moat, I believe that they have several moats. The most obvious moat is the brand moat, as it is a well-known brand that consumers trust. Microsoft certainly also has a switching moat, as switching to a competitor in most cases is not worth the hassle. Later, we will investigate the numbers, but let us first takea look at their management..
Their CEO is Satya Nadella. Before joining Microsoft in 1992, he worked at Sun Microsystems. He held several positions at Microsoft before becoming CEO in 2014 and chairman of the board in 2021. He has a BA in Electrical Engineering, an M.S. in Computer Science, and an MBA. Since becoming the CEO, he has transformed Microsoft's culture by emphasizing empathy, collaboration, and a growth mindset. He has often been described as an exceptional CEO who is highly regarded by his employees. According to Barrons, he has performed very well. Since he became CEO, the stock has increased by more than 700%, and nearly 90% of Microsoft's current value has been generated under his leadership. It makes him one of the greatest value-generating corporate leaders of all time. His credentials mean that I have great faith in Satya Nadella's leadership, and I believe he is the right person to drive Microsoft's growth in the future.
Microsoft has a strong brand and switching moats. I really like the management as well. Now, let us investigate the numbers to determine if Microsoft meets our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will look into is the return on invested capital, also known as ROIC. We want to see 10 years of history, and we want the numbers to be above 10% in all the benchmarks. Microsoft has consistently delivered impressive financial results, surpassing expectations every year for the past decade. It is encouraging to see that the ROIC has been consistently high since 2019, and yet Microsoft has been able to consistently grow their ROIC year over year. I'm very encouraged by these numbers, as every shareholder should be.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. Overall, the numbers look good despite some years where the equity is dropping a bit. As with the ROIC, it is very encouraging to see that Microsoft has grown its equity and has achievedrecord numbers since 2019.
Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Not surprisingly, Microsoft has had a positive free cash flow every year for the past 10 years. The most encouraging thing is that Microsoft has consistently increased their free cash flow year over year since 2015, indicatingthat Microsoft has achieved a record year every year since 2017. Levered free cash flow margin has also consistently remained high over the past 10 years. Free cash flow yield has been relatively low in the last four years, indicating that Microsoft is not currently inexpensive. However, we will discuss this further later on.
Another important aspect to investigate is the level of debt, specifically whether a business has a manageable debt that can be paid off within a period of 3 years. We do this by dividing the total long-term debt by earnings. Doing the calculation in Microsoft, I can see that Microsoft has 0,65 years of earnings in debt, which is very encouraging to see. With a AAA credit rating, debt wasn't going to be an issue, but it is still nice to see the numbers.
Obviously, Microsoft is a great company, and it will most likely continue to grow due to its innovation and strong competitive advantages. However, no investment is free from risk, and investing in Microsoft is no exception. The most obvious risk is competition among the different sectors in which Microsoft operates. Some of their competitors in different business segments are among the best companies in the world, such as Apple, Google, and Sony. Therefore, it is important to have a strong moat, like Microsoft does. Another potential risk could be facing another antitrust law case, as we have witnessed in the past. Right now, it seems like the U.S. Government is primarily focusing on companies such as Apple, Amazon, Google, and Facebook, while Microsoft appears to be avoiding scrutiny for the time being. However, as I have written about previously, with Lina Khan assuming the role of Chairperson of the Federal Trade Commission, I anticipate a rise in antitrust law cases in the United States in the coming years. Given Microsoft's continuous growth, it may become increasingly challenging to evade such cases in the future. Furthermore, Microsoft could also face antitrust scrutiny in other regions of the globe. Lately, there have been rumors that Microsoft will face an informal antitrust review in Europe due to its cloud business. Macroeconomics. As I write this, a recession is looming around the corner. During the dotcom bubble bust and financial/banking crises, Microsoft, like all stocks, experienced a drop in value, although it did perform better than the S&P 500. However, this time might be different, and we don't know if companies will convert to the cloud and if consumers will continue to purchase Microsoft products. Macroeconomics may only pose a short-term risk, but it is still something to consider when investing in Microsoft.
There is also plenty of potential for Microsoft moving forward. They are growing all of their business segments. They continue to expand their business segments. In the latest quarter, revenue from Productivity and Business Processes grew by 13% (17% in constant currency) compared to the previous year. Revenue from Intelligent Cloud grew by 20% (25% in constant currency), and More Personal Computing saw a growth of 2% (5% in constant currency). Microsoft continues to have high margins. Gross profit margin was 68,4% in fiscal 2022, while the operating margin was 42,2%. Furthermore, CEO Satya Nadella doesn't believe that the growth will stop anytime soon. He said that technology as a percentage of total GDP will double from 5% to 10% by 2030. The Metaverse. Microsoft believes that the Metaverse can be the next wave of the internet and describes the first wave as the era when people were allowed to build websites. The next wave, according to Microsoft, is the era where individualscan build their own Metaverse. Microsoft has several assets that can benefit from that, and in a previous earnings call, Satya Nadella said that the Metaverse is an opportunity in a very classic Microsoft sense. Gaming seems to be an obvious winner in the Metaverse, but there is also a desire to bring Teams into the Metaverse through Mesh. It has been mentioned that today's 2D screen meetings may evolve into immersive experiences, where VR or AR goggles are used. LinkedIn. The revenue of LinkedIn has grown by 26% (29% in constant currency) year over year in the last quarter.Microsoft believes that they have only just begun to tap into the potential of LinkedIn. During an earnings call, Satya Nadella expressed his optimism, stating, "I'm very, very bullish on LinkedIn." Cybersecurity. Microsoft has invested a significant amount of effort into cybersecurity in order to provide their customers with a superior product. During an earnings call, Satya Nadella mentioned the possibility of monetizing cybersecurity in the future. When asked about the company's approach to cybersecurity, he stated, "We will definitely monetize those aspects where we have the best-of-breed solutions."
All right, we have gone through the numbers, potential, and risk regarding Microsoft, and now it is time for us to calculate a price for Microsoft. To calculate the price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website. I don't want to go through the entire calculation here. I chose to use an EPS of 9,65 (which is the one from fiscal 2022). I chose an estimated future EPS growth rate of 13%, which is in line with the consensus analysts' expectations. The estimated future PE is 26, which is double the growth rate, considering that the historical highest PE is higher. Additionally, we already have a minimum acceptable return rate of 15%. Doing the calculations using the formula I described in "MY STRATEGY," we arrive at the sticker price (also known as fair value or intrinsic value) of $223,35. We aim to have a margin of safety of 50%, so we will divide it by 2. This means we want to buy Microsoft at a price of $111,68 or lower of course, if we use the Margin of Safety price.
Our second method for calculating a purchase price is the Ten Cap price, which is also explained in "MY STRATEGY".To do so, we need some numbers from their financials. Keep in mind that all numbers are in millions. The operating cash flow last year was 89.035. The capital expenditures were 23.886. I tried to look through their annual report to see how much of the capital expenditures were used on maintenance. I couldn't find it, but as a general guideline, you can expect 70% of the capital expenditures to be allocated for maintenance. This means that we will use 16.720,2 in our further calculations. The tax provision was 10.978. We have 7.496 outstanding shares. Hence, the calculation will be as follows:(89.035 -16.720,2 + 10.978) / 7.496 x 10 = $111,11 in Ten Cap price.
The final calculation is the Payback Time. I also described in "MY STRATEGY". With Microsoft's Free Cash Flow Per Share at 9,94 and a growth rate of 13%, if you want to recoup your purchase in 8 years, the Payback Time price is $145,65.
I believe that Microsoft is a great company with excellent management. I also like their AAA rating, and since they have already faced an antitrust law case previously, they might steer clear of most of these in the foreseeable future. Their competitors are some of the best companies in the world, so they will need to continue to innovate to grow their business. They may also expand their business through acquisitions, such as the ongoing review of the acquisition of Activision Blizzard. I feel very confident in the management's ability to grow the company moving forward, as the CEO has a great track record. There are no 100% safe investments in the world, but in my opinion, Microsoft is one of the companies that comes close to being one due to its great management, huge competitive advantage, and the best credit rating. I usually aim for a 50% discount to intrinsic value when purchasing stocks. However, in certain cases, it is more advantageous to buy a high-quality company at a fair price. I believe that Microsoft is a good buy as long as it is priced below $222, as this would mean it is trading at or below its intrinsic value based on my calculations. The amount of discount you would like on the intrinsic value is up to you.
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