Monitoring Microsoft (MSFT)

[AF Addendum: The Online Stock Study of Microsoft, discussed below, is also summarized in the January 2010 issue of Better Investing magazine.]

Microsoft is the world’s largest software company (based on revenues) and about 80% of its revenue comes from sales of its Windows, Office and Server & Tools software.  However, cloud computing, sometimes called “Software as a Service” (SaaS) is a direct and serious challenge.  As a response, Microsoft’s newest version of Office, now in early testing, will offer online versions of Word, Excel, and PowerPoint that can be used on a computer, Web browser, or mobile phone.

MSFT was the Online Stock Study at the Better Investing website for September that was led by Jim Thomas.  Jim is a director and volunteer educator with the Puget Sound chapter, a software engineer who used to work for Microsoft, and was recently appointed to the board of IClubCentral. Thanks Jim for volunteering.

Each month, the Online Stock Study completes a SSG in about one hour with the judgments made by the online participants using consensus decision-making.  The Consensus SSG, Jim’s presentation slides, and the Value Line report are all available to BI members for downloading.  The recorded session should be available sometime soon.  [AF: it took one month, but the recording finally became available for downloading on 10-6-09]

Jim used the Online SSG which is much more limited than our SSG software.  Among its many limitations, the Online SSG projects future growth only from the last Fiscal Year, ignores Relative Value & Projected Relative Value and provides only one method to decide the Forecast Low Price in the next 5 years.  

 COMPANY BACKGROUND:

- Jim gave a very thorough report on Microsoft’s operations: 95,000 FT employees, 60% in U.S.; 5,000 to be let go by FY 2010; new products include Windows 7 and Office 2010.

- 32% of FY 2009 revenue generated by MSFT’s Business division, 90% from sales of MS Office and 80% of that from sales to business; 25% of revenue from its Client division, 80% from Windows Vista pre-installed on PCs; 24% of revenue from its Service and Tools division, 50% from multi-year licensing agreements; 13% from its Entertainment & Devices division (Xbox, Zune, mice & keyboards); and 5% from its On-Line Services (BING, MSN, Windows Live).

- R&D spending 15% of FY 09 revenue, up from 14% in each of prior two years; revenue down 3% in FY 09, EPS down 13%.

- Jim also reported on: revenue by operating unit and by geographic area; long-term debt; share buy-backs; and dividends.

DISCUSSION:

- I analyzed MSFT previously (on 9-30-08 and 11-21-08) and compared my two SSGs to AnnC’s and to Take Stock;  if you’re interested, see: Monitoring Microsoft

- In the table below, I compare the Consensus SSG to two of mine and to Take Stock.  Armin-1 is my SSG as of 8-18-09, before the Online Stock Study, while Armin-2 reflects my updated SSG.  Following the table, I discuss issues highlighted by the comparison.

MICROSOFT          (MSFT)	Consensus      SSG	Armin-1	Armin-2	Take Stock
Date	9-8-09	8-18-09	9-17-09	9-17-09
Data	S&P Online	S&P	Same	Hemscott- Mstar
Price	$24.80	$23.58	$27.66	$25.30
52 week High &     Low Price	$29.74 &        $14.87	$28.01 &           Same	$27.66 & Same	Not Included
Last Q of                  Reported Data	Q ending          6-09	Same	Same	Same
Software Used	Online SSG	TK 5	Same	TS Online
Project Growth      From End of	Last FY	Last Q	Same	Last FY
Sales Growth	07.80%	09.00%	Same	-03.2
EPS Growth	10.07%	10.00%	Same	-11.0
High PE	17.4	20.5               (four year ave with 2005 out)	Same	22.0
High EPS	$2.65	$2.41	Same	$0.90
High Price	$46.11	$49.40	Same	$19.79                (55% < VL’s        low end)
Value Line Estimated High Price = $45-50 as of 8-21-09
Low PE	09.1	14.0                  (four year ave with 2005 out)	Same	15.8
Low EPS	$1.64                (last FY EPS)	$1.65                   (ttm EPS)	Same	$1.62
Low Price	$14.92                 (low PE x low EPS)	$17.70               (70% of current price)	Same	$25.60                (higher than current price)
Ave % Payout	27.00%(reduced from 78.7%)	26.9%           (four year ave with 2005 out)	Same	Not  Considered
Upside/Down	2.15	4.4	3.1	Impossible to Calculate
Total Return	14.74%	17.3%	15.6%	05.4%
SSG Buy Under	Not Included	$25.63	Same	$10.80
RV/PRV	Not Included	82.7/76.5         (2005 out)	89.0/82.2(Same)	Not Included
Quality	Not Printed	B+	Same	.50(unacceptable)
PTPM – 5 yr ave	41.30%           Trend N/A	Same              Trend down	Same	39.1%                  Trend N/A
ROE – 5 yr ave       End Equity	36.97%            Trend N/A	37.00%            Trend even	Same	Not Included
ROE – 5 yr ave      Start Equity	Not Included	35.7%              Trend up	Same	35.1%                    Trend N/A
Debt to Equity –        5 yr ave	Not Included	01.9%              Trend up	Same	Not Included

(A) THE CONSENSUS SSG:

(1) Quality

- Jim evaluated four aspects of MSFT’s quality and found that 3 were satisfactory: Sales growth at 11.9% over the past 10 years; EPS growth at 11.4%; and Pre-Tax Profit Margin stable at 34-38%

.

- Return on Equity merited further study, Jim concluded, but presumably was satisfactory as it was not considered a red-flag or barbed-wire fence not to cross.

- The Online SSG does not explicitly report the PTPM and ROE trends like our SSG software and Jim missed that PTPM was trending down which is typically considered a red-flag warning sign. 

** However, MSFT’s 5 year average PTPM is 40.30%, some 300% better than its industry average of 13.6% using S&P data, so I’m not worried.  To make this type of comparison, see: Investigating Industry Info.

(2) Estimating Sales Growth

- Jim gave the group three specific choices to estimate Microsoft’s future Sales growth: 11.9%, last 10 year historical growth; 10.0%, Value Line’s Sales per share estimate; and 7.8%, a composite rate that Jim devised (6 year historical + Yahoo Finance FY 2010 & 2011 estimates + VL FY 2012-2014 estimate)

.

- He also offered two other choices that seem pointless: higher and lower.

- Jim did not consider MSFT’s more recent historical Sales Growth (6.9% and 11.4% last 3 and 5 years) and did not mention other analyst estimates for Sales growth (not Sales per share growth): Zacks at 10.62% estimated Sales growth for the next 5 years.

- The Consensus chose 7.8% which is no surprise since that seems to be the only realistic option out of the 5 choices offered.

(3) Estimating EPS Growth

- Because Jim used BI’s Online SSG, all projections were from the end of the last FY (2009, $1.64 EPS) unlike our SSG software which has options to project from the end of the last quarter or from the trend line.  This had no impact on MSFT because the end of its FY was also the end of its last Q.

- Jim also gave participants three choices to determine MSFT’s future EPS growth: $2.89 or 12.0% from S&P’s estimate; $2.73 or 10.7%, another composite rate Jim derived from Yahoo Finance’s FY 2010 & 2011 estimates and VL 2012-2014 estimate; and $2.65 (no rate mentioned), next 3-5 year estimate by Value Line

.

-  He also offered the same two other choices: higher and lower.

- Surprisingly, Jim did not consider Yahoo Finance’s EPS estimate for the next 5 years (10.17%) which seems way more appropriate than relying on its EPS estimates for the next two years.  And, while he mentioned MSFT’s historical EPS growth (11.40%), he did not offer it as an option to the group.

- Perhaps most importantly, Jim did not consider the long-term EPS estimates from other analysts which I discuss under Armin’s SSGs.

- The Consensus chose 10.7%, Jim’s composite rate.

(4) Forecasting High & Low PEs

- Jim offered three choices to Forecast MSFT’s High and Low PEs for the next 5 years: 20x & 16x, from 10% plus or minus VL’s forecast of 18x; 17.4 & 9.1, from 2009 actual; and 15x & 10x, from Jim’s “visual” inspection of the range over the last year.

- Again, he also offered the same two other choices: higher and lower.

- The Consensus chose 17.4 & 9.1, from 2009 actual.

(5) Estimating Average % Payout

- Microsoft paid a special dividend in 2005 that distorted the five-year average. So Jim reduced the 78.70% average to 27.00% in order to estimate the average % payout for the next 5 years.  That is equivalent to treating 2005 as an outlier and averaging the last four years.  This issue was not mentioned in the Presentation Slides.

(6) Forecast High & Low Prices, Upside/Downside Ratio and Total Return

- These also were not mentioned in the Presentation Slides.

- The Consensus did not get a SSG Buy with an Upside/Downside Ratio of 2.15 (under the 3.0 minimum criteria) and a 14.74% Total Return (under the 15.00% minimum criteria).

(B) ARMIN’S SSGs:

(1) Estimating EPS Growth

- When I did my SSG on 8-18-09, the six analysts I always check were estimating long-term EPS at an average of 10.73% with S&P high at 12.00% and Value Line low at 10.00%.  At FactSet CallStreet via CNN Money.com, the Consensus was 11.00% (from 8 analysts who ranged from 13.0 to 5.0%); Zacks.com was 10.62%; Reuters.com was 10.61% (from 11 analysts who ranged from 13.0% to 7.00%); and FirstCall/Reuters via YahooFinance.com was 10.17%.

- When I updated my SSG on 9-17, only S&P had changed its estimate to 10.00% (down from 12.00%).

- I estimated 8.00% EPS both times, well under all the consensus estimates.

- Estimating EPS explains how I estimate EPS for all my SSGs.

(2) Forecasting High & Low PEs

- I eliminated 2005 as an atypical outlier and used the four-year historical average as my Forecast High & Low PEs.

- This was the major difference between my SSGs and the Consensus, and explains why both times I got a SSG Buy with Upside/Downside Ratio > 3.0 and a Total Return > than 15.00% while the Consensus did not.

(C) TAKE STOCK:

- Take Stock is a computerized, one-click program at the StockCentral website that produces an almost-SSG and is designed to generate a conservative result.

- Its EPS estimate for the next 5 years was –11.00% (that’s a minus eleven percent) which seems patently unreasonable and irrational compared to the six analysts I checked who averaged 10.72% and even to the very lowest estimate of 5.00% by one analyst at CNNMoney.

- Because of its low-ball EPS estimate, Take Stock’s Forecast High Price was $19.79, also unreasonably low and a whopping 55% below the low end of Value Line’s $45-50 High Price estimate.  If you’re interested in learning how to judge the reasonableness of SSG judgments, see: Determining What’s Reasonable and What’s Not: An Update.

- Take Stock gave Microsoft a quality rating of .50 on a ten-point scale where a minimum of 3.4 is required to pass muster and 6.7 is desired.  On the other hand, S&P gave MSFT a B+ quality rating.

- Armin

Advertisement