notes of a value investor:
Actually, a Growth-at-a-reasonable-price investor. For the last 4 years, I've done very well by: making a list of companies with good growth records, and pristine balance sheets. Then, I wait till they are out of favor, and selling near the bottom of their PE, P/CF, and/or P/S ranges. MSFT was among the first stocks I put on my list in 1996, but I've never bought it, because it's never been out of favor. Yes, I know the stock is up a bit over that time. That's my discipline. I almost bought the stock in 10/98, but I thought AMAT and INTC were better values with similarly excellent prospects.
Momentum investors can no longer support this stock. MSFT has given up all its 2000 and 1999 gains, broken key support levels, broken below its rising channel. People who buy stocks that have gone from a PE of 50 to 100, hoping to sell to a greater fool at a PE of 200, are not going to be buying MSFT for a while. The stock will not find a bottom until investors like me are buying.
So, when will I buy?
1. Assuming EPS of 0.43 reported on 4/20, trailing earnings are 1.68. 75/1.68 =trailing PE of 45. Yes, I know, using trailing earnings is quaint. (Listening to investors justify stock prices by using earnings estimates further and further into the future, was one of the things that convinced me to go to 70% cash in January 2000.) Usually, I use the 5-year ranges for PE, which is 27-84 for MSFT, which would put us about in the middle of the range, not yet in Value Territory. But, in this case, the industry has changed so much so fast, that I don't think valuation ranges from 1996 or 1997 are useful. Instead, I'll use the 1998 bottom as a benchmark. The low PE for 1998 was 38. So, another 15% drop in the stock, to 64, gets us to the same trailing PE as the 1998 bottom.
2. First Call's consensus EPS for the forward 4 quarters (after the 4/20/00 report) are .43, .43, .49, .49 =1.84. 75/1.84=forward PE of 41. First Call's analyst estimates for longterm EPS growth is 25%. This gives a PEG of 41/25= 1.64. Value investors don't like to buy PEGs over 1. But I don't think the analysts are right about future earnings. So, here's my adjustment: MSFT had beaten EPS expectations by 3-6 cents, each of the last 6 quarters. Lets add 0.03 to each quarter's EPS. That gives a forward PE of 75/1.96= 38. Also, I think longterm EPS increases will be about midway between the past 5 year's unsustainable 45% rate, and the analyst's 25% expected rate. So, now, I get a PEG of 38/35= 1.09. A 9% drop in the stock price, to 68, gets us to a PEG of 1, using my numbers. And, if you consider that Microsoft now has a market cap of 400B, and about 40B in liquid investments (50%cash, 50% volatile equities), I'd be willing to pay a PEG of 1.09 now.
3. Price/sales is now 18. The 5-year range is 5-28, the 1998 low was 8.8. So, to get to 1998 valuations, the stock price would have to be chopped in half, to about 38. But, again, things have changed since 1998. More cash and equities, the internet growth prospects are the good changes. Antitrust problems, earnings deceleration, are the bad changes. Usually, P/S ratios are better value indicators than any ratio derived from earnings, because the creative accountants can't play the same games with sales that they can with earnings. But, because there are limits to how high margins can go, in the long run earnings can't increase at a rate greater than sales. So, the P/S ratios warn that there is still a big downside potential for the stock.
The reasons why the stock is down are not going away anytime in the next 6 months, so I expect a volatile basing pattern through Fall 2000, and more buying opportunities. Those reasons are:
1. Antitrust. Not going to be resolved until 2001, at the earliest. Looks like we'll see a handcuffed Bill, rather than several Baby Bills. The premium valuation for MSFT is largely based on the certainty and predictability of its future. Until the DOJ (and all the me-too suits) is done, we won't get that premium back.
2. EPS deceleration. First call says analysts expect earnings to decelerate, until the earnings reported in January 2001. In that report, they expect EPS of 0.49, with year-earlier EPS of 0.47. After that, earnings growth will accelerate. I'm sceptical of anyone's ability to predict earnings for growth companies, (especially when that growth is coming from the internet) more than 2 quarters out. But those estimates will suppress the stock price for the next 3 months, at least. After that, investors may be looking past them.
3. market risk: overvaluation in the techs, future inflation fears, 3 more Fed rate raises. Again, I don't expect this to be resolved until late 2000.
So, in conclusion: we are in range, but not quite there, for a value investor. I think I'll wait (waiting is something I'm good at), and hope for prices in the 60s, sometime in 2000. If we don't get there, I'll stay on the sidelines. But all it will take is one more day like yesterday. Maybe it'll happen on Monday, maybe not for a few months. Maybe never.
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