• Glenn

Is it time to make Microsoft a part of your portfolio?

Opdateret: 3. maj

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. This analysis shows why I own Microsoft but also suggests if now is the right time to buy the share.

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.

For full disclosure, I should mention that at the time of writing this analysis, I do own Microsoft stocks. 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. Despite me using their products and owning the stock, 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.

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 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 the benchmarks. Microsoft shows remarkable good results and are well above the required numbers. And from the 7-year benchmark and onwards, the ROIC has consistently grown from benchmark to benchmark. These numbers should be a joy to see for everyone that is invested in Microsoft.

The next numbers we will investigate are the Sales Growth Rates. Ideally the numbers should be above 10% in each benchmark and increasing. I'm not concerned that they are slightly under the requirements in the oldest benchmark. On contrary, I'm very happy to see that the sales growth rate is increasing benchmark over benchmark and are now well above 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 delivers in each of the benchmark, as all are above the required 10 %. There has been a decrease in growth from the 3-year benchmark to the 1-year benchmark but it hardly something to be concerned about, as they still delivered a fantastic number in the 1-year benchmark.

The Equity Growth Rate is also known as the most important of the four growth rates. Once again, Microsoft delivers in all the benchmark. And since the 7-year benchmark the growth rate is increasing from benchmark to benchmark, which is fantastic. It is just another proof that Microsoft is a great company.

Finally, we investigate the Cash Growth Rates. I feel like I'm repeating myself, but Microsoft delivers once again. Not only are they above the requirement in all benchmarks, but they are also increasing the growth rate from benchmark to benchmark.

To shortly summarize the five numbers from Microsoft. There are not many companies that deliver historical numbers like Microsoft. Looking at Microsoft they are pretty much a textbook example of a great company. All growth rates are increasing benchmark over benchmark except for the EPS growth rate that had a remarkable numbers in the 3-year benchmark. The equity growth rate and ROIC increased from the 7-year benchmark and onwards, while the sales growth rate and cash growth rate increased from benchmark to benchmark, which is the ideal outcome. ROIC will always be the most important number, and I'm very encouraged to see Microsoft deliver a historical ROIC like they have. Nevertheless, these numbers are historical and doesn't necessarily reflect how the business will perform moving forward. Hence, one should not put too much importance into the numbers alone but use them as a tool out of many when analyzing a company.

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 current cash flow. Doing the calculation in Microsoft, I can see that Microsoft has 0,82 years earnings in debt, which is very nice to see.

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). 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.

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 grew 19 % year over year, while Intelligent Cloud grew 26 % and More Personal Computing grew 15 %. It isn't only the topline that is growing, as Margins are improving as well. Gross profit margin grew from 67,8 % in fiscal 2020 to 68,9 % in fiscal 2021 (it was 64,5 % in 2017, 65,2 % in 2018, 65,9 % in 2019). They are also growing their operating margin from 37,0 % in fiscal 2020 to 42,4 % in 2021 (it was 31,8 % in 2017, 33,5 % in 2018 and 34,7 % in 2019). 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 their latest conference 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 37 % year over year in the last quarter, and Microsoft thinks that they have just scratched the surface when it comes to LinkedIn, and in the latest 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 the latest 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 8 (which is a bit lower than 2021 but higher than 2020). I chose an 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 $240, 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 $120 (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 76.740. The Capital Expenditures was 20.622. 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 14.435,4 in our further calculations. The Tax Provision was 9.831. We have 7.547 outstanding shares. Hence, the calculation will be like this: (76.740 - 14.435,4 + 9.831) / 7.547 x 10 = $95,58 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 8,80 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $138,92.

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. However, the Microsoft share seems rather expensive now, as it is trading above intrinsic value on all my three calculations. The highest intrinsic value is based on the PAYBACK PRICE that with a 50 % margin of safety is $138,92. Meaning that the intrinsic value would be $277,84 based on that calculation. I doubt that you will be able to buy Microsoft at a 50 % discount, so you will need to decide yourself on how much of a discount you need. I can inform you that my cost price on Microsoft is $159.

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.

I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.

Some of the greatest investors in the world believe in karma, and to receive, you will have to give. If you appreciated my analysis and want to get some good karma, I would kindly ask you to donate a bit to Humane Society International. They do a lot of good things for animals around the world, such saving dogs from the dogmeat trade in South Korea and actions against animal testing. If you have a few Euros/Dollars/Pound or whatever to spare, please donate here. Even one or two Euros will make a difference. Thank you.

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