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How Much Is Microsoft Worth?

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If you listen to news reports and look at trading in Microsoft's (Nasdaq: MSFT  ) shares this year, you might think the company is in some dire straits. To be sure, Mr. Softy is facing very real challenges. Its search business badly lags competitors like Google (Nasdaq: GOOG  ) , lower-cost alternatives to the company's business software are trying to make inroads, and its mobile phone platform is still sucking wind compared to the industry leaders.

But at the same time, we're still talking about a company with tremendous financial resources, stellar cash flow, and a collection of software products that far outpaces competitors and claims ridiculously high profit margins.

Has all this pessimism made Microsoft's stock a bargain? Let's take a closer look.

It's a beautiful day in the neighborhood
One way to get an idea of what a stock might be worth is to check out how similar companies are valued. So let's take a look at how Microsoft stacks up.


Total Enterprise Value / Trailing Revenue

Next 12 Months Price-to-Earnings Ratio

Total Enterprise Value / EBITDA

Trailing 12 Months PEG

Microsoft 3.2 11.2 6.9 1
Apple (Nasdaq: AAPL  ) 4.2 16.9 14.1 1
Cisco (Nasdaq: CSCO  ) 2.1 12.6 7.7 1.3
Dell (Nasdaq: DELL  ) 0.3 9.5 4.5 1.7
Google 5.8 18.7 14.2 1.4
Intel (Nasdaq: INTC  ) 2.3 11.1 4.9 1
Oracle (Nasdaq: ORCL  ) 4.8 14.7 12.1 1.7
Average* 3.3 13.9 9.6 1.4

Source: Capital IQ (a Standard & Poor's company) and Yahoo! Finance.
*Average excludes Microsoft.

Using each of those averages to back into a stock price for Microsoft, and then taking the average across those results, we can come up with an estimated price per share of roughly $32. This would suggest today's price of just less than $28 could be undervalued.

A comparable company analysis like this can sometimes raise as many questions as it answers though. For instance, is the entire group properly valued? A supposedly fairly valued -- or even over-valued -- stock among a bunch of other undervalued stocks may actually be an undervalued stock, and vice versa.

Also, while these businesses are comparable to Microsoft, none is a perfect match. Apple could be the most comparable since it competes with Microsoft on multiple fronts, but it doesn't have the same kind of enterprise component and has been hotter on the growth front. Oracle sells enterprise software but doesn't have nearly the consumer side that Microsoft does. Google has a search business like Microsoft, but makes its money primarily through advertising, not software sales. Intel, Cisco, and Dell are tech stalwarts, but all of them are hardware-focused companies.

So with all that in mind, it's best to combine comparable company analysis with another valuation technique.

Collecting the cash flow
An alternate way to value a stock is to do what's known as a discounted cash flow (DCF). Basically, this method projects free cash flow over the next 10 years and discounts the tally from each of those years back to what it would be worth today (since a dollar tomorrow is worth less to us than a dollar today).

Because a DCF is based largely on estimates (a.k.a. guesses) and it attempts to predict the future, it can be a fickle beast and so its results are best used as guideposts rather than written-in-stone answers sent down from Mount Olympus.

For Microsoft's DCF, I used the following assumptions:

Fiscal 2011 Unlevered Free Cash Flow $18.6 billion
FCF Growth 2011-2015 12.0%
FCF Growth 2015-2020 6.0%
Terminal Growth 3.0%
Market Equity as a Percentage of Total Capitalization 96.0%
Cost of Equity 12.0%
Cost of Debt 3.7%
Weighted Average Cost of Capital 11.6%

Source: Capital IQ (a Standard & Poor's company), Yahoo! Finance, author's estimates.

While most of this is pretty standard fare when it comes to DCFs, the academically inclined would probably balk at the way I set the cost of equity. In a "classic" DCF, the cost of equity is set based on an equation that uses beta -- a measure of how volatile a stock is versus the rest of the market -- and a few other numbers that I tend to thumb my nose at.

But when you get right down to it, the cost of equity is the rate of return that investors demand to invest in the equity of that company. So I generally set the cost of equity equal to the rate of return that I'd like to see from that stock.

Based on the assumptions above, a simple DCF model spits out a per-share value of roughly $40 for Microsoft's stock. This would suggest that the stock is even more undervalued than the comparable company analysis let on.

However, I think that number may overstate the case. My starting point for growth assumptions in these models is the current analyst estimates for long-term growth -- and that's the number included in the table above. I happen to think that 12% is more likely a top end for Microsoft's growth over the next five years rather than a "most-likely" scenario. So what I did is I ran the same numbers with a growth range of 4% to 12%. This gives us a valuation range for the stock of $29 to $40 with a midpoint (at 8% growth) of $34.

Do we have a winner?
The valuations that we've done here are pretty simple and, particularly when it comes to the DCF, investors would be well-advised to play with the numbers further before making a final decision on Microsoft's stock.

That said, using the numbers we got above from the comparable company analysis and the midpoint of the DCF valuation range, we could reasonably come to a valuation of $33 for the stock. This would put today's price for the stock at roughly a 15% discount to its true value.

I've got my money where my mouth is on this one -- I own Microsoft shares and it's on my short list of stocks to add to in my portfolio. I think there's significant potential for appreciation here and investors also get a decent 2.3% dividend just for hanging onto the shares.

Want to keep up to date on Microsoft? Add it to your watchlist..

Google, Intel, and Microsoft are Motley Fool Inside Value picks. Google is a Motley Fool Rule Breakers choice. Apple is a Motley Fool Stock Advisor recommendation. The Fool has created a bull call spread position on Cisco Systems. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended buying calls on Intel. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Apple, Google, Microsoft, and Oracle. Motley Fool Alpha owns shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Microsoft and Intel, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.

Read/Post Comments (9) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 31, 2010, at 12:12 AM, dtidtidti wrote:

    There has been a bit of a flurry lately of articles like these pontificating over the value of MSFT. Usually this happens shortly before MSFT goes on a down run. Funny these articles weren't all over the place over the last 6 months while MSFT was bouncing around $25.

    Back in the first quarter when the stock was 30+ there were a ream of articles and analysts recommending the stock as well targeting up to $36. That was just before it dropped like a rock.

    One of the biggest drivers of stock valuation is future growth and MSFT shows no concrete path to any significant increase in business. THAT is why it has a nominal share price and has had for several years. They already own their market and they're not poised to dominate any others in the near future... at least not that hold a candle to the scale of market they currently own. That's also why MSFT has such low volatility.

    This stock is around 70% institutionally owned, so it's the institutions (read hedge funds) that control the volatility of the stock, not the retail investor.

    This article gives some valid reasons why the stock could have different valuations, but those conditions have been the case for the last 6 years. MSFT pricing is determined by different criteria.

    The only thing I've noticed with consistency is that when the advocates start coming out of the woodwork justifying record highs for MSFT, coincidentally, that's usually a good sign to start shorting.

  • Report this Comment On December 31, 2010, at 1:57 AM, gslusher wrote:

    "Basically, this method projects free cash flow over the next 10 years..."

    Which means the validity is somewhere less than zero. (IOW, it's almost surely wrong.) Consider this: ten years ago (2000), what you you have projected would be the situation today? Here's a few things that have happened in those 10 years:

    - 9/11

    - War in Afghanistan

    - US invades Iraq

    - Housing bubble bursts

    - Major investment banks go belly up

    - GM gets taken over by the US government

    - A Republican President and Congress double, even triple the federal debt

    - The Fed has to bail out major banks

    Would you have predicted ANY of those 10 year ago? (To be fair, there were people predicting massive failure in the financial system.)

    Just sticking to popular/consumer technology, here's a few things that happened:

    - The iPod

    - Microsoft is declared an illegal monopoly in the US and EU

    - Cell phones evolve into "smartphones"

    - the iPhone redefines the "smartphone"

    - Big screen plasma & LCD TVs at low prices

    - Blu-Ray

    - Social sites become the most popular part of the Internet

    - Hybrid cars

    - laptops without hard drives

    - the iPad

    - Apple passes Microsoft in market cap

    Now, if you didn't predict at least half of those and can prove it, you have no business doing 10-year estimates.

  • Report this Comment On December 31, 2010, at 3:45 AM, royt123 wrote:

    Mr. Matt Koppenheffer:

    I don't quite understand your AAPL TTM PEG calcuation. As I understand, PEG reflects price-to-earnings growth, measuring a stock's value based on financial growth predictions.

    Apple grew at roughtly 70% in the trailing twelve months (TTM). It's current PE is approximately 21. Therefore, the TTM PEG is 20/70 or 0.03. That's quite a difference from the 1.0 posted. Am I missing something on the math?

  • Report this Comment On December 31, 2010, at 3:47 AM, royt123 wrote:

    To be clear, Apple grew earnings at roughtly 70% in the TTM.

  • Report this Comment On December 31, 2010, at 7:06 AM, afamiii wrote:

    The article misses the point with its over emphasis on numbers.

    The real point is that Microsoft is loosing its competitive advantage in its major market; operating systems.

    People use PCs for: email, web, office productivity, and specialist applications.

    In 10 years their will be more tablet type devices than their will be PCs. The PCs share of use for email and web is rapidly dwindling, office productivity will likely follow.

    The 'assumptions' for free cash flow growth are questionable - GIGO.

    On the other side, Apple have a leading competitive position in a rapidly growing (and extremely important - if not transformational industry), the mobile internet. With its iPhone, iPad and iTunes products. Comparing them to microsoft because they are in the same industry (computers) is laughable.

  • Report this Comment On January 01, 2011, at 1:36 PM, sidste wrote:

    I pretty much agree with all the comments. Today, right now, MSFT is probably fairly valued for the dividend it pays its cash generating capability, but I would not buy with only a 15% margin of safety to "fair value" given that the head winds outweigh the tail winds.

  • Report this Comment On January 09, 2011, at 11:15 PM, TMFKopp wrote:


    Your point is certainly valid -- making projections about future financial performance is extremely difficult and as much art as it is science. Like I note in the article, the idea isn't to assume that you have an absolute answer when you make those projections, but rather to use it as a guidepost.


  • Report this Comment On January 09, 2011, at 11:16 PM, TMFKopp wrote:


    I use 5-year expected growth in the calculation of the PEG ratios.


  • Report this Comment On January 09, 2011, at 11:19 PM, TMFKopp wrote:


    "In 10 years their will be more tablet type devices than their will be PCs. The PCs share of use for email and web is rapidly dwindling, office productivity will likely follow."

    I think you drastically overestimate the ability of mobile devices to take over tasks that PCs/traditional laptops currently perform. Mobility is a great area and will see huge growth, but in many ways it will be additive to what's done on PCs/notebooks/netbooks.


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