Company Description: Microsoft, the world's largest software company, develops PC software, including the Windows operating system and the Office application suite.
Fair Value: In calculating fair value, I consider the NPV MMA Differential Fair Value along with these four calculations of fair value, see page 2 of the linked PDF for a detailed description:
1. Avg. High Yield Price
2. 20-Year DCF Price
3. Avg. P/E Price
4. Graham Number
MSFT is trading at a discount to 1.), 2.) and 3.) above. The stock is trading at a 22.3% discount to its calculated fair value of $35.08. MSFT earned a Star in this section since it is trading at a fair value.
Dividend Analytical Data: In this section there are three possible Stars and three key metrics, see page 2 of the linked PDF for a detailed description:
1. Free Cash Flow Payout
2. Debt To Total Capital
3. Key Metrics
4. Dividend Growth Rate
5. Years of Div. Growth
6. Rolling 4-yr Div. > 15%
MSFT earned two Stars in this section for 1.) and 2.) above. A Star was earned since the Free Cash Flow payout ratio was less than 60% and there were no negative Free Cash Flows over the last 10 years. The stock earned a Star as a result of its most recent Debt to Total Capital being less than 45%. The company has paid a cash dividend to shareholders every year since 2003 and has increased its dividend payments for 9 consecutive years.
Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA) or Treasury bond? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:
1. NPV MMA Diff.
2. Years to > MMA
MSFT earned a Star in this section for its NPV MMA Diff. of the $5,600. This amount is in excess of the $2,600 target I look for in a stock that has increased dividends as long as MSFT has. If MSFT grows its dividend at 14.3% per year, it will take 2 years to equal a MMA yielding an estimated 20-year average rate of 3.6%. MSFT earned a check for the Key Metric 'Years to >MMA' since its 2 years is less than the 5 year target.
Memberships and Peers: MSFT is a member of the S&P 500. The company's peer group includes: Apple Inc. (AAPL) with a 0.0% yield, Oracle Corp. (ORCL) with a 0.8% yield and Google Inc. (GOOG) with a 0.0% yield.
Conclusion: MSFT earned one Star in the Fair Value section, earned two Stars in the Dividend Analytical Data section and earned one Star in the Dividend Income vs. MMA section for a total of four Stars. This quantitatively ranks MSFT as a 4 Star-Strong stock.
Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $36.47 before MSFT's NPV MMA Differential decreased to the $2,600 minimum that I look for in a stock with 9 years of consecutive dividend increases. At that price the stock would yield 2.2%.
Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $2,600 NPV MMA Differential, the calculated rate is 11.7%. This dividend growth rate is lower than the 14.3% used in this analysis, thus providing a margin of safety. MSFT has a risk rating of 2.00 which classifies it as a Medium risk stock.
MSFT is facing several challenges. The company has experienced market share losses in smartphones and mobile devices, and faced difficulties in releasing new products in a timely manner. In addition, the market shift to web-based applications threatens MSFT's Windows PC operating system. However, the cloud movement will provide new opportunities in the deployment and delivery of cloud-based software services. MSFT's server and business application software products are positioned to benefit from the cloud computing.
With strong free cash flow and low debt, the MSFT in an enviably strong financial position. Not to be overlooked, the company ended it fiscal 2011 with over 10 times it dividend in cash and short-term receivables sitting on its balance sheet. With its most recent dividend increase, my analysis indicated that MSFT was a buy below its calculated fair value price of $35.08. I recently initiated a position in the stock, and will look to add to it as market conditions and my allocation allows.
Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.
Full Disclosure: At the time of this writing, I was long in MSFT (0.9% of my Dividend Growth Portfolio). See a list of all my dividend growth holdings here.
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