Should Microsoft be part of your portfolio?
Opdateret: aug. 22
I have previously investigated the FAANG stocks despite not having any of them in my portfolio. However, I do have one big U.S. tech company in the portfolio in Microsoft, which is my second largest position next after BABA.
This is not a financial advice. I am not a financial advisor and I only do these post 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.
I do use quite lot of Microsoft products both at work and in private. However, I only use their software products, where I'm especially fond Office 365 . I have both a Windows based PC and a MacBook, while I have always preferred Playstation over Xbox.
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. Instead, I would like to investigate their moats. I do 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.
We have determined that Microsoft has a brand and switching moats. We really do like the management as well. Now let us investigate the big five numbers in order to see if Microsoft does live up to our requirements for a strong moat. In case you want an explanation about what the big five 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 of the benchmarks. Microsoft shows remarkable good results and are well above the required numbers and have been growing in the last four benchmarks.
The next numbers we will look into are the Sales Growth Rates. Ideally the numbers should be above 10% in each benchmark and increasing. Unfortunately, it is not the case with Microsoft btut the numbers that are below the requirements are by no means alarming, as they are very close to the required 10 %.
The next numbers are the EPS Growth Rates. As with all other growth rates we want the numbers to be above 10 % in all benchmarks. Microsoft fail to meet the requirement in the oldest of the benchmarks but is very close to do so. All the other benchmarks look great and I'm not concerned with the slight decrease in the last benchmark, as it is still above the requirement.
The Equity Growth Rate is also known as the most important of the four growth rates. Microsoft delivers in all of the benchmarks and has actually been growing since the 7 year benchmark, which is something every investor in Microsoft would like to see.
Finally we look into the Cash Growth Rates. Once again Microsoft delivers great numbers. They are slightly under the requirement in the 10 year old benchmark but in all of they others they are well above the requirement.
To shortly summarize the five numbers from Microsoft. They meet the requirement in all benchmarks in the most important of the numbers, which is the ROIC. In the most important of the growth rates, the equity growth rate, they also meet the requirement in all the benchmarks. Hence, it doesn't concern me that they in some of the older benchmarks in sales growth rate, EPS growth rate and cash growth rate are a bit below the requirements. I believe that anyone should be intrigued to invest in a company with these numbers.
Another important thing to look into 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 current cash flow. Doing the calculation in Microsoft, I can see that Microsoft has 1,35 years earnings in debt, which is acceptable.
Obviously Microsoft is a great company and it will most likely continue to grow due to their innovation and because of their strong moats. It is also comforting to know that Microsoft is one out of only two companies that has a AAA rating (the other is Johnson & Johnson). 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, however it is where a strong moat is important. 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.
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. In order 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 a EPS at 5.75 (which is a bit lower than 2020 but a bit higher than 2019). I chose a Estimated future EPS growth rate of 15 (which is usually the highest possible growth rate I use), Estimated future PE 30 (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 $172,50, 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 $86,25 (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". In order 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 60.675. The Capital Expenditures was 15.441. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I wasn't able to 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 10.808,7 in our further calculations. The Tax Provision was 8.755. We have 7.530 outstanding shares. Hence, the calculation will be like this: (60.675 - 10.808,7 + 8.755) / 7.530 x 10 = $77,85 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 6,92 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $109,24.
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 these in the foreseeable future. If you want a 50 % discount to intrinsic value, you will need to wait to open a position in Microsoft until it hits the buy price of $109,24. However, in a company like Microsoft, you might tolerate a lower margin of safety on the company. Personally, I have opened a position at $159 last year and I'm very comfortable at that price.
My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how to do it, you can read this post.
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