Microsoft does not have the profile of a defensive investment based on the requirements of Ben Graham. The Software firm may nonetheless be of interest to more risk-oriented investors who have a solid thesis on the company's future growth. At Market Inference, we remain agnostic as to such further developments, and prefer to use a company's past track record as the bellwether for future potential gains.
Microsoft Is Probably Overvalued
Graham devised the below equation to give investors a quick way of determining whether a stock is trading at a fair multiple of its earnings and its assets:
√(22.5 * 6 year average earnings per share (5.65) * 6 year average book value per share (27.748) = $69.25
After an impressive 34.0% performance over the 12 months, Microsoft is now trading well over its price because its Graham number is 357.1% above today's share price of $316.57. Even though the stock does not trade at an attractive multiple, it might still meet some of the other criteria for quality stocks that Graham listed in Chapter 14 of The Intelligent Investor.
Negative Retained Earnings In 2009 And 2010, A Solid Record Of Dividends, and Eps Growth In Excess Of Graham'S Requirements
Ben Graham wrote that an investment in a company with a record of positive retained earnings could contribute significantly to the margin of safety. However, Microsoft had negative retained earnings in 2009 and 2010 with an average of $24.93 Billion over this period.
Another one of Graham's requirements is for a 30% or more cumulative growth rate of the company's earnings per share over the last ten years.To determine Microsoft's EPS growth over time, we will average out its EPS for 2007, 2008, and 2009, which were $0.50, $0.47, and $0.74 respectively. This gives us an average of $0.57 for the period of 2007 to 2009. Next, we compare this value with the average EPS reported in 2021, 2022, and 2023, which were $8.05, $9.65, and $9.68, for an average of $9.13. Now we see that Microsoft's EPS growth was 1501.75% during this period, which satisfies Ben Graham's requirement.
Microsoft has offered a regular dividend since at least 2008. The company has returned an average dividend yield of 1.1% over the last five years.
Negative Current Asset to Liabilities Balance and a Decent Current Ratio
Graham sought companies with extremely low debt levels compared to their assets. For one, he expected their current ratio to be over 2 and their long term debt to net current asset ratio to be near, or ideally under, under 1. Microsoft fails on both counts with a current ratio of 1.8 and a debt to net current asset ratio of -1.6.
Conclusion
According to Graham's analysis, Microsoft is likely a company of average quality, which does not offer a significant enough margin of safety for a risk averse investor.
| 2017-08-02 | 2018-08-03 | 2019-08-01 | 2020-07-30 | 2021-07-29 | 2022-07-28 | |
|---|---|---|---|---|---|---|
| Revenue (MM) | $96,571 | $110,360 | $125,843 | $143,015 | $168,088 | $198,270 |
| Gross Margins | 65.0% | 65.0% | 66.0% | 68.0% | 69.0% | 68.0% |
| Operating Margins | 30% | 32% | 34% | 37% | 42% | 42% |
| Net Margins | 26.0% | 15.0% | 31.0% | 31.0% | 36.0% | 37.0% |
| Net Income (MM) | $25,489 | $16,571 | $39,240 | $44,281 | $61,271 | $72,738 |
| Earnings Per Share | $3.25 | $2.13 | $5.06 | $5.76 | $8.04 | $9.65 |
| EPS Growth | n/a | -34.46% | 137.56% | 13.83% | 39.58% | 20.02% |
| Diluted Shares (MM) | 7,832 | 7,794 | 7,753 | 7,683 | 7,617 | 7,540 |
| Free Cash Flow (MM) | $47,636 | $55,516 | $66,110 | $72,699 | $95,608 | $112,921 |
| Capital Expenditures (MM) | -$8,129 | -$11,632 | -$13,925 | -$15,441 | -$20,622 | -$23,886 |
| Net Current Assets (MM) | $95 | -$6,468 | -$8,674 | -$1,092 | -$7,385 | -$28,614 |
| Long Term Debt (MM) | $76,073 | $72,242 | $66,662 | $59,578 | $50,074 | $47,032 |
| Net Debt / EBITDA | -1.23 | -1.27 | -1.13 | -1.08 | -0.88 | -0.56 |
