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Technology Stocks : How high will Microsoft fly? -- Ignore unavailable to you. Want to Upgrade?

To: Wizard who wrote (8639)	6/24/1998 5:08:00 PM
From: Arnold Layne	Read Replies (1) \| Respond to of 74651

To All: AG Edwards raises MSFT from 'reduce' to 'maintain' biz.yahoo.com Don't you love these analysts? I bought MSFT a couple of weeks ago for $84, and now I found out I should have ben 'reducing' my MSFT holdings. Now 20 points later I'm supposed to 'maintain'! I don't know if this came before or after the close. ARNOLD

To: Wizard who wrote (8639)	6/25/1998 8:41:00 AM
From: Reginald Middleton	Read Replies (2) \| Respond to of 74651

<Whoever said that book value is what a company is worth? The difference between the market value and the book value is the premium/discount paid on the carrying value of the underlying assets. Companies with identical book values can have very different profitablity and growth characteristics.> You can express the value of a firm in book value. You just mentioned the method a few post ago when referring to the WACC/EVA methodology. The problem is you can't do it the accural accounting way. The Stern Stewart school aggregates the accounting book value of all capital, reconociling it so as to get the economic book value (which is suppose to closely track market value) and potential return on invested capital, adjust it for risk by applying a risk charge through the WACC. The alleged difference between the economic book value and the actual market value is the market's view on the potential profitability of current and future investments and confidence in management. The caveat with this method is that in many cases it is not stringent enough, for with the assistance of computer technology you can actually mark these economic assets (capital available to investors and invested capital) to market and the get the market value of the assets in lieu of accounting and economic book. This gives you a very realistic picture (in real time) of how the market is viewing the company's operations. <So company X's book value was Y on June 24, 1998 and the current market value is 3x that. Who's to say how far into the future investors are discounting? They could be discounting a book value of Z at the end of the this year or they could be discounting a book of ZZZ in 2010. The assumption that book = market value is not a part of accounting.> Discounting one year into the future is mathemetically futile, as nearly any academican will tell you. Theoretically, it should not matter how far you discount into the future, as long as you adhere to the 3 to ten year period that reflects economic reality and the limitd ability to forecast realistically into the future. As for the assumption that book = market value not being part of accounting, many old school practitioners use book value as a valuation measure. They just can't rely on the accrual accounting measure as a reliable metric, so they end up reconciling the numbers. I can not answer your entire post, since I have to go, but I will leave a point to ponder. Cash flow enthusiasts will always be at odds with those who believe in accounting earnings. Companies with big investments like MSFT's will have to take one of two distinct paths. If you believe the market truly values earnings, you will capitalize whenever possible to maximize earnings (notice that MSFT NEVER DOES THIS). Companies that believe in the market valuing cash flows will expense everything as soon as possible to get full advantage of all possible tax deductions (notice that MSFT often does this. Who do you think the market would value most? This is the reason many on this thread are perplexed at why SMFT is trading at such a high P/E ratio. They are looking as E instead of CF (cash flow). If MSFT did not plow so much of thier economic earnings back into reinvestment such as R&D (nearly three billion dollars), marketing (over 1 billion dollars, I think?), revenue deferrals (could be well over a billion dollars at about 423 million a quarter - this is an assumption, I didn't look it up - revenue deferrals act as a call option against future cash flow volatility), the E would be much larger than it currently is. Instead of trying to justify why the market awards MSFT such a high PE ratio, one should simply understand that the market is not valuing MSFT on Earnings at all, but gross cash flows (see the correlation analysis on my site). Thius is the reason why small high tech stocks get such high PE's, they plow thier economic (real) earnings back into reinvestment (R&D, marketing, M&A) hence don't produce much in terms of accounting earnings. Therefore thier P's grow faster than thier accounting E's. Their actual market value does not change (except to reflect the incresed cash flows due to avoided taxation and the increased potential of revenue generation through higher investment), just thier P/E ratio. A company with the same gross cash flows would get the same market valuation, less the adjustments that I just mentioned in the parenthesis. As the small high tech company matures, less money is put into the reinvestment (R&D, marketing, M&A) and more is attributed to accounting earnings, which tends to produce a lower P/E, but the same aggregate market valuation (less adjustments for the items that I bracketed above). This is what makes MSFT such a phenomenal investment. At its size and age, it still investing and reinvesting at a breakneck clip. This gives MSFT the additional boost in marekt valuation (the bracketed adjustments), as well as boosts its P/E by reducing its E (which is no big deal to those who no better that to follow E's) RCM rcmfinancial.com