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By BenGrahamMan
October 31, 2008

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Just my two diluted and devalued cents.

Here are some quick notes from the 10-Q.

1. Part of cash flow went down this quarter because of a one time payment to the IRS of $3.1B for an examination of the years 2001 - 2003.

2. Earnings in 1Q08 were $4,373 versus 1Q07 of $4,289. Had tax rate stayed at 1Q07's rate of 31%, then 1Q08 earnings would have been $4,134. EPS would have been $0.45.

3. R&D is 15% of Revenues.

4. Inventories increased 66%. Most of inventory is in finished Goods.

5. Short Term Debt of $1,975 occurred for the first time.

6. Tangible Equity was $19,404. This is 58% of total book value. Previous year Tangible equity was $22,205 or 61% of Total Book Value.

7. Free Cash Flow.

�             3 months 9/08     3 months 9/07
CFO          3,370                 5,878
Dividends   (998)                 (938)
CapEx       (778)                 (510)
FCF          1,594                  4,430

I think if you added the $3.1B IRS payment to the 1,594 FCF 1Q08, you would have FCF of 4,694.

8. Common Stock Repurchased for 1Q08 was $4.5B.

9. Level 2 assets are $15.2B.

10. Interesting posts on Microsoft Board were:

A. Embedded Computing Observations http://boards.fool.com/Message.asp?mid=27143328

B. Interesting doubts by excellent poster Jonkai http://boards.fool.com/Message.asp?mid=27124089

11. We use Comcast business at work. We were just moved over to a Microsoft Exchange Server by Comcast. This is for remote access. The interface is excellent. Use is excellent. I would imagine that MSFT is profiting from this.

12. I looked at Unearned revenue quickly, and all looked okay to me. This was also mentioned on the conference call. I bring this up because Jonkai on other board discussed it, and believes that MSFT is Cookie Jarring revenues.

13. All segments seem to be strong. Growth in Online service and advertising.

Guidance from CC

1. 2Q08 revenue of 17.3 to 17.8B.
2. Full year revenue of 64.9 to $66.4B.
3. Expects revenue growth to be greater than IT market.
4. Capex to be reduced to about $3.7B

Quick Thoughts

I think valuation is compelling. Yet, I have thought that for a few years now. I quickly modeled 5% EPS growth for 15 years, using a terminal value of 2X book in year 15, and come up with mid teen ROI's.

Management has longevity and apparent integrity and competency. I trust that MSFT is more knowledgeable on YHOO situation than me and all the analysts. Company appears conservative in their accounting. They expense everything and do not seem to capitalize much at all. Hence when using comps, that needs to be considered. Extremely well capitalized. AAA rated. Certainly thesis can fail if MSFT is disrupted by GOOG, AAPL or any open source vendor , company or cloud. Huge moat in Windows and all related products. I can't think of a technology company, or any company for that matter where there cash flows can somewhat be predicted in a conservative manner. Other than tax rate changes, I really don't see any areas for quality of earnings issues. Share buybacks could blossom. Unearned revenues, although a concern, will turn into higher stockholder equity when realized. Hopefully there will be continued replacement of Unearned Revenue. Is it wrong to look at this in a manner similar to insurance company float? Forward P/E is less than 10. I see yahoo computes a PEG of around 1. I need to verify when I analyze this. Insiders own 13% and institutions own 60%. Dividend has been increasing and payout ratio for quarter was 27%. ROE looks like it could over 40% this fiscal year.

Two minute drill

Company is a leader in IT. They cover gaming, entertainment, online, all business applications and advertising. Spend a lot on R&D. Because of current valuation, you could have mid teen annualized ROI. Especially since company is AAA and really has no economic climate risk. Has inherent technological disruption risk. I would rate that risk low. Company continues to grow. All fundamentals appear solid. No apparent possibility of permanent loss of capital. I have studied this company for several years, and management appears consistent and does not appear to over-promise under deliver. I feel there is a terrific margin of safety. Interestingly enough, if they do bring on debt to say 25% of equity, Wall Street in her demented mind might place a higher valuation because of "properly deployed capital." No interest rate exposure apparent. Hopefully no false certainties in my analysis. Tier 1 company, and I believe I used ultra conservative growth assumptions.

The above is just an exercise. Please do your own dd, and the above could be error filled, very quick and haphazard mentions. Here is some old stuff I have at my page http://rbcpa.com/companies/MSFT.html