>Most of your questions have been answered at
>http://www.rcmfinancial.com/sample4 (although it does need to be updated, I will
>not do that here, but I will notify you when I update my site's analysis). Since it is a
>decent amount of work, I will not rehash, but ask you to read it.
It definitely needs updating, especially the part that talks about how IE4 was supposed to come out in October. Admittedly, we all thought that at the time, but it didn't work out that way.
>For a quick recap
>on valuation:
> - If risk free rate = 6.4% with low end growth, fair valuation is $273
> - If risk free rate = 8.2% with low end growth, fair valuation is $113
> - If risk free rate = 10% with low end growth, fair valuation is $79.86
>
> - If risk free rate = 6.4% with moderate growth, fair valuation is $342
> - If risk free rate = 8.2% with moderate growth, fair valuation is $150
> - If risk free rate = 10% with moderate growth, fair valuation is $97
I have a hard time understanding how these figures are derived, and your web page does not give me much help.
How do you come up with your assumptions about Microsoft's future growth in earings and cash flow?
I assume you are treating what you call the "risk free rate" as some sort of discount rate and using it to arrive at the present value of future earnings. Am I correct? If so, how does one derive the correct risk free rate of return in the real world? Is it the long bond rate? If not, what is it?
>For actual P/E's check out
>http://www.rcmfinancial.com/sample4/html/msft_dcf_valuation_matrix.htm
I looked and I didn't see any discussion of Price Earnings ratios, just another one of your hard for us non-experts to understand spread sheets.
What multiple of earnings do you think Microsoft should be priced at for it to be fairly valued in the present marketplace under present conditions?
>><Which company will have the bigger Market Cap in five years?>
>Sorry, but the batteries died in my crystal ball last night.
Aw shucks, Reg, I guess you didn't use Energizers! If you want, I'll lend you mine. :)
>><Or are you standing in for Reginald because he's afraid to admit what a truly
>>objective valuation analysis of Microsoft's current stock price would show?>
>You must've been drinking when you posted that one!
Heavily. :)
>><When you've given us your analysis, I'll let you know what I think.>
>As long as you use sound, logical reasoning or back up your statements with sound
>numbers.
The numbers I use come from the Value Line Investment Survey. The logical reasoning I employ to place what I think is a fair value on a stock is: for a mature growth company like Microsoft I do not want to buy the stock at a price earnings multiple which exceeds the company's growth rate.
So, here goes:
Microsoft earned $3.60 in the last twelve months. Value Line estimates it will earn $4.10 in 1997.
Here are Value Line's past and projected growth rates for Microsoft:
(I have no idea how they define these terms or come up with their estimates for the future growth rates.)
.............Past 10 years.........Past 5 years.......Future
Sales...........42.0..................37.0..............24.0
Cash Flow.......42.5..................41.0..............20.0
Earnings........48.5..................39.5..............22.0
Book Value*.....56.5..................43.5..............26.5
*Admittedly a worthless concept in the software field, but I include it for completeness, since it was in Value Line's chart.
Note that Microsoft's current trailing price earnings (as of November 15, 1996) ratio of 41.38 exceeds the sales, cash flow and earning five year growth rate figures.
Arbitrarily, I will use the earnings growth rate figures to calculate what I think is a fair value, but if you use cash flow or sales the figures will not be that different.
Here's my table of fair valuations (earnings multiplied by growth rate):
Based on:...Actual 1996 Earnings of $3.60...Projected 1997 earnings of $4.10
Assuming:
22 percent growth....................$79.25..............................90.25
(Value Line Estimate)
40 percent growth....................144.00.............................164.00
(rounding up past earnings growth
to the nearest whole percentage and
extrapolating it into the future)
30 percent growth....................108.00.............................123.00
(an arbitrary middle of the
road figure)
Question is: which valuation is right?
I think the very best that can be said for Microsoft is that it is fully and fairly valued at $149 per share (actually, fair value is $144 a share).
Here is my reasoning:
Of course, we all "know" Value Line's 22 percent projected growth are probably too conservative for an aggressive company like Microsoft. So, throw those figures out.
On the other hand, extrapolating Microsoft's past growth into the future is extremely risky. How is a company with a market cap of $90 billion supposed to grow for 40 percent a year? Personally, I just don't think it is going to happen.
Management is excellent and, with no debt and billions in cash, finances could not be better. Micorsoft also has a brand-name franchise which is of some value. But consider all of these factors, which have been discussed on this thread before:
1. Companies like Corel and Oracle are (or will be shortly) eating into Microsoft's cash-cow Office Suite and back-end server businesses. In the OS market, NT is expected to be a barn burner. NT could be big like Microsoft says it will be, or it could flop (i.e., disappoint inflated expectations), like Windows 95 did.
2. Microsoft's core OS and Office Suite markets are SATURATED. How many more people out there are going to buy Office Professional With Bookshelf?
3. To try to keep its industry leadership position in the age of the internet, Microsoft is spending hundreds of millions, if not billions, to develop software for the internet which it is GIVING AWAY.
4. Microsoft's internet strategy ISN'T WORKING. For example, in browsers, in spite of the fact Microsoft gives theirs away, Netscape still dominates. While Microsoft spends billions to develop software it gives away, Netscape SELLS its browsers and servers in the corporate intranet market and dominates that market. Even in the public internet space, Microsoft does not lead, let alone control, standards; as Ballmer admitted in his recent News.com interview, Microsoft still has to "embrace" standards developed elsewhere. They have not gotten to the "extend" part yet.
5. In the home entertainment/on-line services field, Microsoft is losing hundreds of millions a year to establish its brand franchise. I agree that these should eventually pay off, even give Bill Gates his goal of a recurring income stream, but how soon and how big will the payoff be? What are the risks? Of more immediate concern, how do they sustain the 40 percent per annum earnings growth needed to justify their current stock price with a billion dollar black hole like MSN to deal with?
A realistic future growth projection for this $90 billion market cap company is probably closer to 30 percent than 40 percent, but even if we generously assume a 40 percent per year growth rate, multiplying that by actual trailing earnings of $3.60 as one is supposed to in this type of valuation analysis, fair value is $144.00.
Your comments are welcome. |
