Microsoft (MSFT) is the world’s largest software maker. As you’re probably painfully aware, the company holds a virtual monopoly on desktop operating systems and office suites. Microsoft is divided into five business units: 1) Windows and Windows Live which is responsible for the Windows operating system, which over 90% of all PCs use. 2) Server and Tools is responsible for producing various sever related products and providing support for them through Microsoft Consulting Services. 3) Online Services Business is responsible for Bing, MSN, and Microsoft’s online ad sales. 4) Microsoft Business which is responsible for producing Microsoft Office. 5) Entertainment and Devices which is responsible for the Xbox entertainment center. MSFT is currently transitioning its business away from PCs and into the online world. The company strongly believes that software should exist as a product (software installed on a PC) and as a service (software in the cloud). We will see how this vision unfolds over time.
MSFT Basic Company Stats
- Ticker Symbol: MSFT
- PE Ratio: 15.33
- Yield: 3.29%
- % above 52 week low: 25.3%
- Beta: 0.9
- Market cap: $234.1 B
- Website: www.microsoft.com
MSFT vs the S&P500 over 10 years
MSFT seems to be alternating between underperforming the S&P500 and moving on par with it. By the end of 2012, an investment in MSFT would have increased by about 18% compared to about 63% for the S&P500 as a whole. Just for fun, I played with various time periods to see if buying on dips would have let MSFT beat the S&P500, but it looks like the best you’ll get in terms of capital appreciation is matching the S&P500.
MSFT Earnings Per Share (EPS) & Dividend Growth
- 5 year EPS growth: 1.7%
- 10 year EPS growth: 9.0%
- 5 year dividend growth: 15.3%
- 10 year dividend growth: 28.4%
EPS growth for MSFT have been slowing down over time. Also, MSFT’s dividends have been growing much faster than its EPS, however this is not surprising given that it appears that MSFT is transitioning into becoming a stable dividend paying stock. I suspect that the slowing of EPS will continue over the short term. The 10 year dividend growth rate is 28.4%, the 5 year growth rate is 15.3%, the 3 year growth rate is 20.9%, and the 1 year growth rate is 24.6% This dividend growth rate is very impressive, however dividend growth can’t exceed EPS growth forever, so this is a trend that can’t continue forever.
With a starting yield of 3.3% and a growth rate of about 15%, MSFT’s yield on cost will grow to about 13% in 10 years. In order to double the dividend, using the rule of 72, it will take approximately 5 years.
In case you are wondering what happened in 2005, MSFT payed out a one time special dividend.
MSFT Payout Ratio
MSFT’s payout ratio has been relatively stable over time time and is currently below 40%. The huge payout ratio in 2005 is due to the one time special dividend. The average payout ratio over the last 10 years (excluding the special dividend) is 25%. I really like how low this payout ratio is and I feel that it leaves a lot of room for dividend growth.
MSFT Cash Flow Per Share and Revenue
- 10 year revenue growth (2003-2012): 9.6%
- 5 year revenue growth (2008-2012): 5.1%
- 3 year revenue growth (2010-2012): 8.6%
MSFT has been consistently increasing it’s cash flow per share and revenue over the last 10 years. The fact that these continue to grow means that there will likely continue to be growth in EPS and dividends.
MSFT Balance Sheet
The current debt to equity ratio of MSFT is 16%, which is much lower than other equities (~40%). MSFT only started taking on substantial long term debt in 2009, so it remains to be determined if they will continue to take on additional debt or if they will try to keep their debt burden at low levels. At this point, I am not concerned
The biggest risks related to Microsoft center around it’s almost pathetically slow entry intro the mobile computing area. But Microsoft has been working to correct that. Recently Microsoft released the Surface tablet. Which is a nice device, but even more overpriced than the iPad. Microsoft as also allied itself with Nokia (NOK) to gain entry into the smartphone market. I’m not certain that Microsoft will make easy inroads into the mobile arena, but Microsoft has enough resources at its disposal to stay in for as long as it takes to produce winning products.
MSFT Valuation Panel
The Graham number represents one very simple way to value a stock. The Graham number for MSFT is $18.84. The current stock price is well above that, suggesting that MSFT may be overvalued at the moment.
Two Stage Dividend Discount Model
Using a risk free rate of 2%, an expected return of 10% and the beta of 0.9, the CAPM model provides a discount rate of 17.2%. Using an initial growth rate of 20% for 5 years and a slower growth rate of 7%, the two stage model produced a value of $13.81 I also tried this model with a discount rate of 10% and got $47.61.
I feel that the two stage model is the way to go because of the very high current dividend growth. However, I’m uncertain which is the best discount rate to use. If you average the two, MSFT is nearly fairly valued. My gut feeling is that MSFT is fairly valued at the moment, maybe a little undervalued.
MSFT Cash Secured Puts
I feel that MSFT is at an attractive price to consider writing cash secured puts against it.
Overall, I like MSFT and feel that it is appropriately valued. I think it has several more years of solid dividend growth left in it before the rapid growth starts leveling off. May main reservation is with MSFT’s inability to beat the S&P500 in terms of capital appreciation. Pending availability of funds, I may increase my position in MSFT, but not before looking for some other options.
Disclosure: I am currently long MSFT.
Readers: What are your opinions about Microsoft?