Monitoring Microsoft (MSFT)

 

 

 

Microsoft (MSFT) is the world’s largest maker of computer software with 2008 revenues of $60.4 B (up 18%).  Morningstar reports that Windows and Office software account for roughly 60% of MSFT’s revenue with another 22% coming from enterprise server software.

 

Microsoft is a large, mature company which, contrary to conventional wisdom, continues to grow both sales and earnings.  Its 5-year average Sales was 13.2% which increased to 18.1% in 2008 while EPS increased from 18.2% to an impressive 31.7%.

 

The company is remarkably profitable with a 5-year average Pre-Tax Profit Margin of 42.4%, nearly 2.5 times greater than its industry average of 17.3%.  According to Morningstar, MSFT generates more than $1Billion in cash each month and, after buying back $40Billion of its stock over the last two years, still has a whopping $30Billion in cash.

 

While MSNMoney.com is an excellent website (especially its free Custom Deluxe Stock Screener), MSFT’s Online division lost money in 2007.  That’s probably why Microsoft offered to buy Yahoo! in early 2008 for $44.6B or $31 per share, and may try again next year.  However, Morningstar believes that would be “an unmitigated disaster” and suggests other acquisitions that would better compliment Microsoft’s core strengths, such as SAP (enterprise software) or RIMM (the Blackberry mobile phone).

 

In late 2008, Microsoft finally opened an online store where customers can conveniently buy all of the company’s products.  Most of its software is now available for download and all of it can still be bought in a box.

 

Software as an online service directly challenges MSFT’s old business model which sold everything in a box.  Microsoft and the software industry is changing, and Wikinvest reports that revenues from all online software is expected to grow from 5% to 25% in the next three years.  Moreover, Microsoft’s latest version of its Office software will offer online versions of Word, Excel and PowerPoint that can be edited and managed by a computer, a web browser, or a mobile phone.

 

Unlike Apple, Microsoft does not have a reputation for innovative products, snazzy design, or technological excellence.  Opening an online store is hardly a major break-through. And, Morningstar is surprisingly pessimistic about MSFT’s ability to prosper in the long, long term, estimating 8.3% average growth over the next 5 years and fading to merely 3.0% after 2012. 

 

“[I]n the long term, the services model will change

industry economics such that Microsoft’s growth

slows to inflation and its returns fade to match its

cost of capital.”

 

Here’s a comparison of AnnC’s SSG from BI’s First Cut with two of mine and with Take Stock.

 

Microsoft (MSFT)	AnnC	Take Stock	Armin-1	Armin-2
Date	10-3-08	10-22-08	9-30-08	11-21-08
Data	S&P	Hemscott	S&P	same
Price	$26.32	$23.36	$26.15	$19.68
52 week High & Low Price	$87.50 & $23.50	n/a	$37.50 & $23.50	$36.72  $17.50
Project Growth From	Last Annual & Last Quarter are same (A)	Last Annual	Last Quarter	same
Sales Growth	09.00%	12.50%	09.00%	same
EPS Growth	09.20% (B)	09.30%	09.00% (D)	same (E)
High PE	21.5 ave High PE after 2 outs	24.7	20.0 2008 lowest in last 5 yrs	15.0
High Price	$62.60	$72.25	$57.60	$51.90
Value Line Estimated High Price = $50-60 at $21.20 on 11-21-08 and $55-65 at $28.12 on 8-22-08
Low PE	12.0 (C)	18.6	14.5	10.9
Low Price	$21.00 80% x current price	$34.60	$22.20 recent severe low	$10.50 60% of 52 week low
Upside/Down	6.8		8.0	3.5
Total Return	20.1%	27.1%	31.4%	40.5% (untrust- worthy)
SSG Buy Under	n/a	$39.09	$31.07	$20.85
RV & PRV	75.3 & 68.9 (2 outs)	n/a	74.7 & 68.6 (2 outs)	46.8 & 43.1 (2 outs)
RV & PRV (no outs)	n/a	n/a	63.8 & 58.5	39.9 & 36.8
Quality	n/a	TS = 5.8, excellent	S&P = B+	same
PTPM – 5 yr ave	42.2% trend even	39.0% trend n/a	42.4% trend even	same
ROE – 5 yr ave End Equity	32.2% trend up	n/a	32.2% trend up	same
ROE – 5 yr ave Start Equity	n/a	29.6% trend n/a	30.7% trend up	same
Debt to Equity – 5 yr ave	n/a	n/a	-0- trend even	same

 

(A) My SSG file contains data for 4 Qs 2008 and for 2008 annual so starting growth projection at last Quarter or last Annual makes no difference;

 

(B) Ann explains in her SSG from First Cut that she relied on the Preferred Procedure for her 9.2% estimated EPS, even though it was less than the analysts.

 

- For her PP, Ann used 9.00% as her Sales estimate which she said was between 8.3% from Morningstar’s and 10.2% from VL & Yahoo-Finance.  However, when I checked on 10-22, Yahoo-Finance was estimating Sales next year at 9.2% (not 10.2%) and VL was estimating Sales per share at 17.0% (not 10.2%) for the next 3-5 years.  Zacks, the only source that estimates Sales for the next 5 years, was estimating 11.29%.

 

- Moreover, if Ann had just used the VL estimate for Shares Outstanding, her PP would have increased to 13.5% EPS. 

 

(C) For her Forecast PEs, Ann reduced her Low PE from its 15.6 average to 12.0, because of our “very pessimistic market”, but used her High PE average of 21.5.  In contrast, I never adjust one High or Low PE without modifying the other.

 

(D) When I did my SSG on 9-30, the six analysts I always check were estimating long-term EPS at an average of 12.58% with VL high at 17.00% and First Call via Yahoo Finance low at 11.19%.  Zacks was 11.29%, and three were 12.00% (S&P, Reuters via Morningstar, and FactSet Call Street via CNN Money).  No estimate had changed when I checked again on 10-22.

 

(E) When I updated my SSG on 11-21, these six analysts were now estimating long-term EPS slightly lower at an average of 12.26 with VL still high but lowered to 15.50% and First Call via Yahoo still low and still the same at 11.19%.  Zacks was still the same at 11.29%, Reuters via Morningstar was slightly lower at 11.60%, and FactSet CallStreet and S&P were still the same at 12.00%.

 

CONCLUSION:

MSFT has continued to drop in price and, even though I lowered my judgments considerably, I consider my SSG untrustworthy primarily because of its unusually high Total Return of 40.5%.

 

 

 

 

- Armin