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

To: DavidD who wrote (12610)	11/25/1998 5:30:00 PM
From: Gerald Walls	Read Replies (1) \| Respond to of 74651

Ever heard the term "risk adjusted return?" No? Yes, it's a quantifiable number calculated using the risk of certain events occurring and their effects if they do occur. Projected earnings are adjusted by the weighted consequences of the effects on earnings and the results used to calculate a risk-adjusted fair market value. Another interpretation uses the fluctuation in the price of a security (usually a mutual fund in this case or perhaps bonds) to adjust the return so that securities with different risk profiles can be more fairly compared. An example would be a bond with a 10% probability of being defaulted on would have to have a total return to maturity of 111% of that of a bond with 0% probability of default (Return/(1-0.10)). Well adjusting for the risk that MSFT could have it's 1/3 it equity wiped out, no matter how much cash or shares they have on hand, it would seem the current p/e is very high. OK, what is your risk-adjusted PE for MSFT? What probability are you assigning the possibility that the price of MSFT will drop 40% and they'll have all the warrants put to them over a period of 2-1/2 years? 0%? 5%? 50%? 95%? Why? If you can't answer this then how are you "adjusting for the risk?" Quantify.

To: DavidD who wrote (12610)	11/25/1998 6:39:00 PM
From: Reginald Middleton	Read Replies (1) \| Respond to of 74651

<Well adjusting for the risk that MSFT could have it's 1/3 it equity wiped out, no matter how much cash or shares they have on hand, it would seem the current p/e is very high. > I'm quite familiar with risk adjusted return. With corporate entities, the risk is usually measured by it's cost of capital, which in the case of public companies are easily derived from the market's pricing of debt and equity. MSFT's cost of capital is relatively low, with its beta/volatility being lower than that of the S&P 500. The market is well aware of MSFT's ESO funding approach and they still award MSFT low cost equity capital. So, on a risk adjusted basis, MSFT has relatively low risk (as compared to the S&P 500) with a cost of capital of about 9.7% and relatively high return of about 30% compounded annually. I seriously recommend that you read the piece I linked to earlier in regards to earnings. You excessive use of the term P/E in regards to MSFT leads me to believe that you may not be aware how little value earninngs are in the valuation of a high growth company such as MSFT.