Microsoft’s Price Falls -0.9%. Is It Fairly Valued?

By Chris Stiles • Tuesday, November 01 12:00 • Permanent Link

This morning Microsoft has lost 0.9% of its value and underperformed the S&P 500 and Dow Industrial composite indices by 0.3% and 0.3% respectively. The large-cap Technology company ended the day at $230.11, closing in on its 52 week high low of $219.13 and is 25.02% below its average target price of $306.91. Over the last 12 months, Microsoft is down -30.3%, and has underperformed the S&P 500 by 13.9%. The stock has an average analyst rating of buy.

Microsoft has a trailing 12 month price to earnings (P/E) ratio of 24.8, which corresponds to its share price divided by its trailing earnings per share (Eps) of $9.29. The company's forward P/E ratio is 20.7 based on its forward Eps of $11.11.

Earnings refer to the net income of the company from its sales operations, and the P/E ratio tells us how much investors are willing to pay for each dollar of these earnings. By way of comparison, the Technology sector has historically had an average P/E ratio of 26.5. Whether the company's P/E ratio is within a high or low range tells us how investors are currently valuing the stock's earning potential, but it doesn't tell us how its price will move in the future.

Another metric for valuing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present value of the company if it sold all its tangible assets and paid off all debts today. Microsoft's P/B ratio of 9.9 indicates that the market may be overvaluing the company when compared to the average P/B ratio of the Technology sector, which is 5.57.

To understand Microsoft's business, and therefore its attractiveness as a potential investment, we must analyze its margins in two steps. First, we look at its gross margins, which take into account only the direct cost of providing the product or service to the customer. This enables us to determine whether the company benefits from an advantageous market position:

2021 gross margins: 68.4 %
2020 gross margins: 68.9 %
2019 gross margins: 67.8 %
2018 gross margins: 65.9 %
Average gross margins: 67.8 %
Average gross margins growth rate: 1.3 %
Coefficient of variability (lower numbers indicate more stability): 2.0 %

Next, we consider the Microsoft's operating margins, which take into account overhead. This tells us whether the company's business model is fundamentally profitable or not:

2021 operating margins: 42.1 %
2020 operating margins: 41.6 %
2019 operating margins: 37.0 %
2018 operating margins: 34.1 %
Average operating margins: 38.7 %
Average operating margins growth rate: 7.3 %
Coefficient of variability (lower numbers indicate more stability): 9.8 %

Since both Microsoft's gross margins and operating margins tend to be positive, we know that its business is currently profitable. However, it's important to take into account their variability and overall growth trend to make a definitive conclusion regarding the company's strength.

To get a better idea of Microsoft's finances, we will now look at its cash flows. Often touted as a general yardstick for a company's financial health, cash flows represent the sum of inflows and outflows of cash from all sources, including capital expenses:

2021 free cash flow: $65,149,000,000.00
2020 free cash flow: $56,118,000,000.00
2019 free cash flow: $45,234,000,000.00
2018 free cash flow: $38,260,000,000.00
Average free cash flow: $65,149,000,000.00
Average free cash flow growth rate: 19.5 %
Coefficient of variability (lower numbers indicating more stability): 23.2%

This is the pool of liquidity that the company can use to reinvest in its business and to pay its equity investors a dividend. Investors in Microsoft enjoy a dividend yield of 1.1%, and they can expect this to continue based on the company's positive cash flows.

Overall, Microsoft seems to be a strong business with an attractive valuation in numeric terms. Potential investors may want to take a closer look at the stock, and focus on whether it also has qualitative factors that show that it can provide solid returns. For more daily equity reports, make sure to subscribe to our free newsletter!

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.