Tuesday, September 20, 2011


Here's a just a quick note on the cheapness of Microsoft (MSFT).  Microsoft is a controversial stock; some feel it has great value and others feel it is a value trap, an old dinosaur on it's way out.

David Einhorn among other notable value investors have taken a decent stake in this company.

The primary bear case, I think, is simply that PCs and laptops will be pushed out completely by iPads and smart phones, and what's left of PCs and laptops will be taken over by 'cloud' software providers.

Anyway, let's take a quick look some basic figures for MSFT.

Here are some figures for the past six years from their investor day presentation last week (materials are available at the MSFT website):

           Revenues         EPS
2006    $44.3 bn         $1.20
2007    $51.1 bn         $1.42
2008    $60.4 bn         $1.87
2009    $58.4 bn         $1.62
2010    $62.5 bn         $2.10
2011    $69.9 bn         $2.69

During this period, MSFT grew revenues at an average of 10% per year, operating earnings at 11% per year and EPS at 18% per year (EPS grew faster due to large share repurchases).

This is not a bad performance for a dinosaur business in a really awful economic environment with high unemployment and businesses not spending.

At around $27/share, MSFT is trading at a mere 10x the most recent fiscal year EPS.  That is mighty cheap.  EPS estimates for this year and next year are:

Year ended
June 2012:     $2.86
June 2013:     $3.13

So MSFT is trading at 9.4x current year and 8.6x June 2013 earnings.

This is without including the large amount of cash and short term investments on MSFT's balance sheet.

A quick look shows that MSFT has cash, cash equivalents and short term investments of $ 52.8 billion as of the end of June 2011 and $10 billion in equity investments for a total of $62.8 billion.  Long term debt as $12 billion and other long term liabilities was $8.1 billion (presumably tax liabilities) so net of that, their net cash and investment position would be $42.7 billion.

With 8.4 billion shares outstanding, that comes to $5 per share.  Since these investments don't generate too much income, I won't bother to adjust the eps (other income is less than 3% of pretax income, I think).

Deducting the $5/share from a $27 MSFT stock price would mean you are getting the operating business for $22/share.

At $22/share, you are getting MSFT at 8.2x last year's earnings (ended June 2011), 7.7x current year estimate and 7x  2013 estimate.

Also, MSFT has been paying dividends recently.  Here are the dividends paid in the recent past:

2007    $0.40
2008    $0.44
2009    $0.52
2010    $0.52
2011    $0.64

Dividends have grown 12.5% per year recently, and again, during one of the worst periods in economic history.   With a $0.64 dividend paid last year, MSFT is trading at a 2.4% dividend yield, compared to a ten year treasury yield of less than 2.0%.

That is pretty cheap and it does look like the market is pricing MSFT as a true dinosaur.

I don't have too strong a view on this, but at this price, I do think the risk/return is pretty attractive.  As always, there is risk and it is difficult to project out what the technology industry will look like in five or ten years, but there is a price where things can get very interesting.

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