My focus on value-based investing opportunities over the years has, in many cases, led me to pass over some of the most dominant players in a respective industry or sector. That’s been especially true as the stock market’s bullish trend extended itself into the longest upward trend in recorded history. A big piece of the market’s massive run to the upside since 2009 is reflected in the gains of some of the biggest names, not just in corporate America, but on a global scale as well. There are really just a handful of companies in the United States that fit the description I’m giving, but Microsoft Corporation (MSFT) is definitely one of them.
Ih the Technology sector, MSFT occupies an interesting spot. They’re globally recognized as a dominant factor in every market they are involved in, but they tend to generate far less media attention than some of their nearest competitors, including Apple (AAPL), Alphabet (GOOGL), and Amazon (AMZN). APPL has the iPhone, which remains the most popular smartphone on the market; GOOGL owns internet search and is really considered the only legitimate contender to APPL’s smartphone dominance; and AMZN is the unquestioned online retailer of choice. Those seem to be the sexier, more buzz-worthy areas of the tech sector that most investors want to pay attention to, and less on MSFT’s particular niche, which has been defined for decades now in every aspect of the personal computing space.
The truth, of course is that all four of the companies I just mentioned have made their own respective, and significant inroads into the business segments of their competing brethren. None of them are one-trick ponies, no matter what you might think of first in each case. That’s a big reason that all four make up the biggest companies in the United States, based on market cap. I find it very interesting, however that while MSFT generates the least amount of attention from market pundits and experts, it remains the largest capitalized company in the world, and as of this writing the only company with a market cap in excess of $1 trillion. The others are close, and have even flirted with that magic numbers, but MSFT is the only that has managed to hold above that level.
MSFT has been a buy-and-hold investor’s dream for the last ten years. From a 2009 low around $15 per share, the stock has increased in value to a little over $132 as of this writing, with only occasional pauses in the stock’s steady upward climb. Much of 2018 proved tumultuous for tech stocks, with high levels of volatility that forced those stocks into big swings between short and intermediate-term trend extremes. MSFT was the exception, only submitting to the broad’s market momentum in the last quarter of the year to decline a little over -15% before using the market bottom on Christmas Even to launch into a fresh new trend. Even the market’s May drop lower only saw MSFT drop a few dollars, and then use that short-term low as a springboard to push to a new all-time high that it is only a little bit below right now.
Stocks at the highs I’m talking about are the kinds of stocks that I don’t usually pay attention to, and as you’ll see, that’s because their valuation levels are simply to high for me to reasonably consider them to be any kind of realistic value play. I don’t buy into the mindset that some analysts use, which is to estimated growth figures to determine valuations. Growth forecasts, especially those that come directly from the company, can be expected to paint the rosiest, pie-in-the-sky scenario that management thinks they can sell to the rest of the market. That’s why I prefer to focus on historical performance; while it is true that “previous performance is not a guarantee of future success,” I do tend to believe in the notion that a company with a consistent pattern of fundamental strength is far more likely to maintain that pattern than they are to diverge from it.
MSFT’s fundamentals are nothing less than impressive, but it is clear to me that the market has consciously decided to push the stock to levels that are far above its historical valuation levels. Does that mean that the market is changing the way it looks at the company? I don’t think so; I think it reflects the reality of an extremely extended bull market more than anything else. From a long-term perspective, I think that when the end of this latest bull market comes – whenever that may be, soon or late – MSFT is a stock that could see a significant drop in price, simply because of how extended it already is.
Why am I suggesting you should pay attention to MSFT anyway? Because the fact is that the company has done better than many other tech stocks at diversifying its business into a variety of segments, occupying major positions in everything from search to social media to cloud storage and collaborative computing. This is also a company with a massive store of cash and liquid assets, and that is actively using the cash to return value to its shareholders. Along with steadily increasing dividend payouts, MSFT has bought back more than $10 billion of its own stock over each of the last four year, with most indications showing that both patterns are likely to continue. That fact alone could provide shareholders with an interesting buffer against an extended price drop, even if a bear market comes sooner than later.
Fundamental and Value Profile
Microsoft Corporation is a technology company. The Company develops, licenses, and supports a range of software products, services and devices. The Company’s segments include Productivity and Business Processes, Intelligent Cloud and More Personal Computing. The Company’s products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games, and training and certification of computer system integrators and developers. It also designs, manufactures, and sells devices, including personal computers (PCs), tablets, gaming and entertainment consoles, phones, other intelligent devices, and related accessories, that integrate with its cloud-based offerings. It offers an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and it provides solution support and consulting services. MSFT’s current market cap is $1.013 trillion.
Earnings and Sales Growth: Over the last twelve months, earnings increased 20%, while sales grew nearly 14%. In the last quarter, earnings growth was modest, at about 4%, while sales dropped by about -5.8%. MSFT’s margin profile is a major source of strength; Net Income was about 28.5% of Revenues for both the last twelve months as well as the most recent quarter.
Free Cash Flow: Taken in terms of the number alone, MSFT’s free cash flow is massive, at a little over $33.6 billion for the trailing twelve month period; given the company’s market cap, it translates to a misleadingly modest Free Cash Flow Yield of 3.29%.
Debt to Equity: MSFT has a debt/equity ratio of .70, a relatively low number that doesn’t really tell the story sufficiently. MSFT’s balance sheet shows $131.6 billion in cash and liquid assets against $72.5 billion in long-term debt. This disparity is something that has been a characteristic of MSFT for a couple of decades, at least, and is the reason that the company that has been so active for the last four years in buying back their shares as well as increasing their dividend payouts.
Dividend: MSFT pays an annual dividend of $1.84 per share, which translates to an outsized yield of 1.39% at the stock’s current price. The yield doesn’t sound impressive, that is true; but the company is employing a modest, long-term strategy of dividend increases that makes the sustainability of that increase as close to a certainty as anything in the stock market can be.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MSFT is $12.32 per share and translates to a Price/Book ratio of 10.78 at the stock’s current price. Their historical Price/Book average is 6.64, which suggests that the stock is actually overvalued by about -38% and puts the stock’s long-term target price at around $82 per share. Their Price/Cash Flow ratio offers approximately the same perspective, since it is currently running about -39% above its historical averages. That ratio puts a long-term target price at about $81 per share. These numbers are the primary reason that while I’m impressed by MSFT fundamental profile, I simply can’t call the stock a smart value play.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the last two years of market activity for MSFT. Long-term price movements are often a good indication not only of how the market feels about a company, but also of the reality of the stock’s fundamental status. Even the last two years don’t really do justice to the stock’s increase over the decade, but this does provide a good look at the strength of the stock’s upward trend. I just wrote that MSFT can’t be considered a smart value play, and I stick by that opinion; but the stock’s strong trend, and impressive fundamentals do make for a very interesting argument for its continued growth potential. The stock broke above its latest resistance level at around $129 just about a week ago to set a new all-time high a little above $134 per share. $129, then is the stock’s current support, with $134 providing the best evaluation of the stock’s most likely immediate resistance.
Near-term Keys: Given the strength of the stock’s trend, I think the smart approach is to simply watch to see what the stock does with the support and resistance levels I just identified. If it breaks above $134, it could see short-term upside of about $10 per share (based on the relative size of the stock’s decline in May before it rebounded higher), to about $144 per share. That could be a very nice signal to place a bullish trade either by buying the stock or using call options. A break below $129 would mark a drawdown against the stock’s upward trend, but the best opportunity for a bearish trade wouldn’t really come unless the stock picks up a lot of bearish momentum. The highest-probability bearish signal would come from a break below the stock’s May low point at around $120 per share, which could signal a technical reversal of the stock’s long-term downward trend. A smart trader wouldn’t trade this stock on a bearish basis, either by shorting the stock or working with put options, until that break happens. What about the value proposition? Based on its valuation metrics, MSFT’s bargain price is around $65 per share. I’m not sure the stock is going to drop that far at any point in the foreseeable future; but if the stock does drop below $100, or approach its “fair value” around $81, it could translate to a bargain opportunity that is just too compelling for even a die-hard value investor like myself to pass up.