This month, we’re going to dig into Microsoft. This is one that I’ve been looking at for a while for my son since they are the owner of Mojang and Minecraft.
Let’s start by looking at Microsoft’s financial ratios. Their Debt-to-Equity ratio is the highest of their industry segment at 1.2. That doesn’t particularly scare me as they brought in about $11 billion dollars in cash in the last quarter, according to their SEC filings. $11 billion in cash generation puts them at a run rate of about 21 months to generate enough cash to equate their total debt load. Most of their debt is being used to buy back shares of the company as well as pay their dividend. They are borrowing very short term funds at less than .5% interest rates.
They are currently trading at 30.40 times their earnings. This is quite expensive for Microsoft historically. Their 5 year average P/E ratio is 21.65 and the 13 year average P/E ratio is 15.95. These indicate to me that the stock is pretty highly valued right now. Their current annual earnings adding the last quarter of the previous annual report is $2.27 per share. We’re primarily interested in seeing where the stock will be in a year, so with a projected growth in earnings of 9.7% over the next year that would put earnings per share at $2.49. If we use their historic average P/E ratios that puts the stock price between $39.71 and $53.91. If you review their earnings reports, you’ll notice that their sales have been consistently transitioning from the old stoic aspects of their business to primarily cloud based. Along with the improved technology advancement in the cloud, Microsoft is very conscientiously buying back shares of their own stock.
Let’s dig into their share repurchase program next. In the last quarter they bought back $1.6 billion dollars worth of their stock. These repurchases were done at an average price of $64. That should give us some additional insight as to what the directors feel the company should be valued at and give us somewhat of a faux floor under the stock price. That is approximately 7.2% below the current stock price. Their total outstanding repurchase agreement has the authority to purchase an additional $38.6 billion dollars worth of the company stock. That consists of about another 559 million shares, which if they are all purchased would boost the stock value by about 7.25%. Using the P/E ratios we figured in the last paragraph, if you increase the stock price by the 7.25% that could come from the repurchase you’d have the stock price between $42.59 and $57.82.
I also am a fan of the fact that they are continuing to improve and increase their dividend. A really interesting fact about their dividend, is that they are able to borrow commercial paper at well under 1% in order to fund growth as well as pay dividends if they need the cash for the dividend payment. At 2.26% currently, the dividend is solid (around the 10 year treasury bill) and they generate free cash flow of around $2.20 a year so their current dividend of $1.56 yearly is a little higher on the scale than I would like to see. Also, of great importance to the dividend consideration is the fact that they are buying back large portions of the company, so that doesn’t show as free cash flow but they could always slow down the repurchase if they need to do that in order to keep the dividend strong. Also, within the last year they have raised their dividend by just under 10% from .36 a quarter to .39 a quarter. That is an excellent way for an investor to continue to compound their wealth through a stock investment. Dividend growth may be better for the long term investor than actual stock price appreciation.
They have done a great job at transitioning from a hardware company (PC) to a software, service, and cloud company, which improves their ability to obtain recurring monthly income over just selling a product that will last for a couple of years.
I wouldn’t want to buy Microsoft at this time, unless I could get in under $60 per share. I’d be willing to sell cash covered puts at $60 until the shares were forced onto me. That way we’re collecting premiums and wouldn’t be worried about the actual stock price. We’ll update our target and buy price as we get new information, but I could see this stock falling over the next year to somewhere in the $62 range.
Make every day great,