To: johnd who wrote (8672 ) 6/25/1998 6:24:00 PM From: Reginald Middleton Read Replies (2) | Respond to
You forgot to add the other investments and financing sources. R&D for FY 97 =$1,925 and marketing for fy 97 = $2,865. Summed together, this gives you nearly 4.8 billion extra dollars in gross income (you mentioned SGA and R&D but you must realize that marekting and R&D are investments and not expenses. At a 35% tax rate, that leaves you with $3,107.65 of earnings that would have gone to the net income to common line (accounting earnings) if MSFT participated in the accounting game. Divide that by the 1.312 million shares outstanding and you get an additional $2.37 of earnings per share that are not accounted for (notice that I didn't use the delta in R&D and marketing since MSFT actually plows economic earnings into these activities on a regular basis). Now, add that to your figure adjusted for deferred earnings (I don't know if you used the last 12 months or the most recent annual report but I hope this illustrative example gets the point across) and you get nearly double your estimated earnings. Add a discount for the lack of growth caused by the lack of future investment and penalty for excess taxation due to the lack of tax shields, and you get a true P/E of nearly half of what you are complaining about (somewhere aroung 25 to 30). Mind you that we did not truly reconcile the income just by adding back deferred revenue, and other long term investments. There are a plethora of other things that need to be looked at as well such as deferred domestic and foreign taxes, warranty reserves, bad debt reserves, capitalized leases, LIFO reserves, contingency reserves, etc. My models reconcile up to 135 accounts, depending on the industry, in an attempt to pierce the accouting veil and get to the true economic earnings potential of the corporate entity. All of these accounts serve as quasi-equity capital to investors as well as act as an interest free financing to the company that draws interest and investment income and can be put to work for capital expenditures and working capital without being taxed or showing up on the books (sans the fine print in the footnotes of course). If one insists on valuing a company via earnings instead of cash flow, then the P/E that you are lookng at will drop even further. You compared MSFT to Coke, but forgot to take into consideration the type and frequency of the tax shielding and reinvestment. Look at teh difference in R&D bewteen Coke and MSFT. Take Coke's earnings dollars and put them where MSFT's R&D dollars are, and you will approach convergence in P/E. Due to the complexity of all of this mixing and matching, there is a school of thought that says "to hell with earnings, all we want is the money". You know where I stand on that.
