Things Are Pointing Up for Microsoft

Ron is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If there was one company that did not provide any significant shareholder return even in spite of exceptional performance in the last few years, that is Microsoft. As is written in this article:

[...] the Microsoft example provides is how there was such a separation between business results and stock performance. Clearly, Microsoft, the business, performed exceptionally well from 1999 until today. However, because the price was so insanely overvalued, shareholder returns were poor in spite of strong operating results.

As a matter of fact, a company's performance and its shareholders' returns are two completely different things. That's where the term 'value' comes in. In this article, I want to research a bit about the present value of Microsoft (NASDAQ: MSFT) and where the stock price might be heading from here.

One of the best valuation indicators can be the price estimates by the analysts. According to Investorguide.com, here is a list of price estimates as per popular analysts. And it does not seem too inspiring to me. In fact, the stock's target price has been revised downward in the last 3 weeks.

Is Microsoft really getting overvalued?

If I consider $25 as the average price for the last 5 years, then Microsoft is currently trading above its mean stock price. Can we justify the uptrend? With Windows 8 not doing so good and the PC market going down, we may not have enough valid reasons to justify the current stock price.

It can be noticed though that the non-corporate insider transactions have leaned far too much on the 'selling' side. Non-corporate insiders can be expected to be not interested in taking over a company. They are mainly focused on wealth maximization, as are we. And why are they selling more than they are buying? Are the insiders not so confident about the company? Or are they knowledgeable about the imminent stock price decline?

One interesting thing to note is that the institutional investors have not changed their positions much in the last three months. Should we be following the 'big money'?

Institutional Holdings:

65.00% (as of 02/28/13)

Bought (Previous 3 Mo):

422.26 million

Sold (Previous 3 Mo):

425.65 million

Total Held:

5.45 billion

Institutions:

3.29 thousand

Non-Corp. Insider Holdings:

9.20% (as of 01/31/13)

Bought (Previous 3 Mo):

15.13 thousand

Sold (Previous 3 Mo):

5.05 million

Let us take a look at the various valuation ratios now.

Fundamental valuation

Price-to-earnings ratio: The interesting thing to note about Microsoft's PE ratio and stock price is that while the price has been relatively trading around the average level for the last 5 years, the PE ratio is at its lowest right now since 2010.

With EPS expected to reach $3.50 by 2015, the price has potential to grow. Right now, the PEG ratio seems to have reached the upper limit. With any positive updates from Microsoft, the PEG ratio should go down, with PE ratio going up, raising the valuation of the company.

Price-to-book ratio: The P/BV ratio is at its lowest in the last 10 years.

If you look at the table below though, shareholders' equity has gone up exponentially since 2010. With $63 billion in short-term investments and $10.7 billion in long-term debt (only $1.23 billion of that counted as current) as of December, 2012, the company seems to be in a healthy financial position. 

 

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Cash

49.05B

60.59B

37.75B

34.16B

23.41B

23.66B

31.45B

36.79B

52.77B

63.04B

Current Assets

58.97B

70.57B

48.74B

49.01B

40.17B

43.24B

49.28B

55.68B

74.92B

85.08B

Total Assets

79.57B

92.39B

70.82B

69.60B

63.17B

72.79B

77.89B

86.11B

108.70B

121.27B

Current Liabilities

13.97B

14.97B

16.88B

22.44B

23.75B

29.89B

27.03B

26.15B

28.77B

32.69B

Total Liabilities

18.55B

17.56B

22.70B

29.49B

32.07B

36.51B

38.33B

39.94B

51.62B

54.91B

Stockholder' Equity

61.02B

74.83B

48.12B

40.10B

31.10B

36.29B

39.56B

46.18B

57.08B

66.36B

Needless to say, the book value per share should go up in the coming few years. $2.31 billion worth of investment in fixed assets in 2012 is not going to go to waste, I am sure. And that's when the P/BV ratio is going to rise to the normal level. In fact, the current book price is $40.52, the price at which the stock should trade to achieve the average P/BV level of the last 10 years.

Price-to-cash flow ratio: Looking at the table below, FCF has a CAGR of 7.8%.  

 

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Free Cash Flow

14.91B

13.52B

15.79B

12.83B

15.53B

18.43B

15.92B

22.10B

24.64B

29.32B

Growth %

 

(9.32)

16.79

(18.74)

21.04

18.67

(13.62)

38.8

11.5

19

With the discount rate being taken as 15%, the current discounted growth price is $38.65. The current stock price seems undervalued by 35.03%.

The FCF has grown steadily in the last 5 years, except for 2012. Perhaps, the transition-to-mobile phase is taking its toll on the company, which I hope to get resolved by the end of 2015.

Price-to-sales ratio: When we look at the image below, it is clear that the P/S ratio is also riding at its lowest since 2010. Why? Revenue has been rising steadily since late 2009 to $73 billion by the end of 2012. With the PC market still growing in single digits, I really don't see any reason why the P/S ratio should go down that drastically. It is as if the market forecasted future decline in revenue without any valid reason, reflecting that in the P/S ratio.

And that is in contrast to analysts' estimates that sales should reach $92 billion by the end of 2015. It must be noted though that revenue is expected to stall following that. According to me, it is still too far-reaching at the moment. One right acquisition and the whole scenario might change.

Having said that the company might be undervalued in comparison to itself, it is always good to verify the same in comparison with the immediate peers as well. Let us look at the comparative valuation analysis of the company.

Companies

Price/Earnings Ratio

Price/Book Value Ratio

Price/Sales Ratio

Microsoft Corp

15.65

3.58

3.22

Intl. Business Machines

14.71

12.29

2.25

Oracle Corp

14.95

3.59

4.05

Hewlett-Packard Co. 

NA

2.06

0.38

Apple

10.16

3.59

2.71

Even though Microsoft might be fundamentally undervalued, it still seems overvalued when compared to Apple (NASDAQ: AAPL) and Oracle (NYSE: ORCL). If we consider the growth potential in the mobile market, Apple seems to be better valued than Microsoft. As per recent data, Apple stands second in the global smartphone market, after Google's Android. And in terms of profitability margins and financial health, Oracle seems far more investor-friendly than Microsoft. IBM (NYSE: IBM) with a dividend yield of 1.59% is definitely overvalued and would probably see a downward adjustment in the coming year. Moreover, with the high LT debt-to-equity ratio at 176 times, and below average profitability margins, IBM's stock price is probably overvalued at the moment. 

Conclusion

Looking at the fundamental and technical metrics mentioned above, it can be safely said that Microsoft stock price has the potential to soar in the future. Not to mention the fat dividends that you will probably enjoy alongside. With its sheer size of around $240 billion, this company has the necessary 'economy moat' a technology company dreams about. One of the tech giants in the world, Microsoft is a good bet for your investing money.


Ron Chatterjee has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple, International Business Machines., Microsoft, and Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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