Microsoft: The greatest stock in the world?
Opdateret: 19. apr.
Some refer to Microsoft as the greatest stock in the world. I understand why some refer to Microsoft that way, as it is one out of only two companies with an AAA credit rating (the other is Johnson & Johnson), it has delivered tremendous growth over the years, and their products don't seem to be in demand for years to come. The question is if now is the time to buy the stock? In this analysis, I will try 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 is currently 2,57 % of my copy trading portfolio. If you would like to copy the portfolio or see what stocks I hold, you can read how to do so here. I see Microsoft as a compounder, and I don't expect to close the position any time soon. Despite owning Microsoft, I will keep this analysis unbiased.
Microsoft is a multinational technology company that is based in the United States. I do not want to go too much into details about the company as I expect that everyone already knows about it. However, one should know the different business segments of the company. Microsoft operate and report their financial performance using the following business segments: Productivity and Business Processes, Intelligent Cloud and More Personal Computing. In short, Productivity and Business Processes included Office 365, LinkedIn, and cloud-based applications. Intelligent Cloud includes Azure but also 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 very well-known brand that consumers trust. Microsoft certainly also have 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 have a look at their management.
Their CEO is Satya Nadella. Before joining Microsoft in 1992 he worked at Sun Microsystems. He held several positions in Microsoft before becoming CEO in 2014, and chairman of the board in 2021. He has a BA in electrical engineering, a M.S in computer science and an MBA. Since he become the CEO, he has transformed Microsoft's culture by emphasizing empathy, collaboration, and growth mindset. He has often been described as a particularly good CEO that is popular among his employees. According to Barrons, he has performed very well. Since he became CEO, the stock is up more than 700 %, and close to 90 % of the 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 the leadership of Satya Nadella, and I believe he is the right person to grow Microsoft moving forward.
I believe that Microsoft has a brand and switching moats. I really do like the management as well. Now let us investigate the numbers to see if Microsoft does live up to 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 investment 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 delivered great numbers and is above the requirement in every single year for the last 10 years. It is encouraging to see that the ROIC has been specifically 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 share holder should be.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Overall, the numbers look good despite some year where the equity is dropping a bit. As with the ROIC, it is very encouraging to see that Microsoft has grown their equity and have had record numbers from 2019 and onwards.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Not surprisingly, Microsoft has had a positive free cash flow every year in the last 10 years. The most encouraging thing is that Microsoft has consistently grown their free cash flow year over year from 2015 and onwards, meaning that Microsoft has had a record year every year since 2017. Levered free cash flow margin has also been consistently high throughout the last 10 years. Free cash flow yield has been relatively low in the last 4 years, which indicates that Microsoft isn't cheap now but we get back to that later.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculation in Microsoft, I can see that Microsoft has 0,65 years earnings in debt, which is very nice 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 their innovation and because of their strong moats. However, no investment is free from risk, and neither is investing in Microsoft. The most obvious risk is competition among the different sectors that Microsoft operates in. Some of their competitors in different business segments are among the best companies in the world, as they include Apple, Google, Sony etc., Hence, it is important to have a strong moat like Microsoft has. Another risk could be another antitrust law case, as we have seen previously. Right now, it seems like the focus from the U.S. Government is towards companies such as Apple, Amazon, Google, and Facebook, while Microsoft seems steer clear for the time being. However, as I have written about previously, as Lina Kahn has become the Chairperson of the Federal Trade Commission, I believe that we will see an increase in antitrust law cases in the United States in the coming years, and as Microsoft grows bigger and bigger, it might be difficult to avoid it in the future. Furthermore, Microsoft could also face antitrust scrutiny in other parts of the world. Lately, there are rumors that Microsoft will be facing an informal antitrust review in Europe due to their cloud business. Macroeconomics. As I write this, recession is looming around the corner. During the dotcom bubble bust and financial/banking crises, Microsoft dropped like all stocks, even though it did perform better than the S&P 500. However, this time might be different, and we don't know if companies will concert into cloud and if consumers will continue to buy Microsoft products. Macroeconomics may be a short-term risk, but it is still something to be aware of when investing in Microsoft.
There are also plenty of potential for Microsoft moving forward. They are growing all their business segments. They continue to grow their business segments, and in the latest quarter Productivity and Business Processes revenue grew 13 % (17 % in constant currency) year over year, while Intelligent Cloud grew 20 % (25 % in constant currency) and More Personal Computing grew 2 % (5% in constant currency). Microsoft continue to have high margins continue to be high as well. Gross profit margin was 68,4 % in fiscal 2022, while operating margin was 42,2 %. Furthermore, CEO Satya Nadella doesn't believe the growth will stop anytime soon. He said that tech 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 internet and described the first wave is where people were allowed to build website, and the next wave is where they can build their own Metaverse. Microsoft have several assets that can benefit from that, and in a previous earnings call, Satya Nadella said that the Metaverse is an opportunity in very classic Microsoft sense. Gaming seems to be an obvious winner in the Metaverse, but they also want to bring Teams into the Metaverse through Mesh and mentioned how today's 2D screen meetings may change into even immersive experiences, where you use VR or AR goggles. LinkedIn. The revenue of LinkedIn has grown 26 % (29 % in constant currency) year over year in the last quarter, and Microsoft thinks that they have just scratched the surface when it comes to LinkedIn, and in an earnings call, Satya Nadella stated: "I'm very, very bullish on LinkedIn". Cybersecurity. Microsoft has put a lot of effort into cybersecurity to deliver a better product to their customers. And in an earnings call, Satya Nadella stated that they might monetize cybersecurity moving forward, and when asked about cybersecurity, he said: "We will definitely monetize those aspects that 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 price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 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' expectation), Estimated future PE 26 (which is the double of growth rate, as the historical highest PE is higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $223,35, and we want to have a margin of safety on 50 %, so we will divide it by 2 meaning that we want to buy Microsoft at price of $111,68 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "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 was 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 though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning 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 like this: (89.035 - 16.720,2 + 10.978) / 7.496 x 10 = $111,11 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 9,94 and a growth rate of 13 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $145,65.
I believe that Microsoft is a great company with a great 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 grow their business through acquisitions, like the acquisition of Activision Blizzard that is currently under review. I feel very confident in the management being able 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 because of great management, huge moat and the best credit rating. I usually want a 50 % discount to intrinsic value when I buy a stock but in some cases i is just better to buy a wonderful company at a fair price. I believe that Microsoft is a buy under $222, as it then trades at intrinsic value or lower on all my calculations. The amount of discount you would like on intrinsic value is up to you.
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