Microsoft (MSFT) is the largest independent maker of software. Microsoft develops and sells software products for a wide range of computing devices. Most people will be familiar with Microsoft Office programs such as Word, Excel and Powerpoint. Microsoft has a computing operating system known as Windows which is prevalent in most PC’s on the market. Gamers will be familiar with the popular XBox gaming system. MSFT has shown their commitment to paying yearly increasing dividends to their shareholders as they have increased their dividend for 10 years in a row.
Dividend Growth and Current Yield
Microsoft currently pays a dividend of $0.23 per quarter for a $0.92 annual dividend. At the close of market on Thursday, January 10th MSFT’s price per share was $26.46. This gives the stock a current dividend yield of 3.48% (0.92/26.46). Typically I look for a dividend yield of at least 2.5% so I would be satisfied with this dividend yield from MSFT.
In 2003, Microsoft began paying an annual dividend amount of $0.08 per share. The dividend trend has been up each year as it now pays $0.92 annually per share. This gives MSFT a 10 year annual compound dividend growth rate of 27.66% which is a pretty good growth rate. More recently the annual dividend growth rate was 23.08% for 2011 to 2012 and 15% from 2012 to 2013. This is a good rate of dividend growth for shareholders to enjoy. Microsoft has shown a commitment to it’s shareholders with their decade long history of increasing dividends. As long as they continue to increase their dividend at a faster rate than inflation, shareholders should be happy.
Earnings Per Share Growth
MSFT had a 2002 earnings per share (EPS) of $0.94 and a 2012 EPS of $2.72. Over the 10 years their earnings per share have been consistently climbing upward at a strong rate with only one down year in 2009. MSFT has had a 10 year EPS growth rate of 11.21% which is a great growth rate. More recently MSFT’s annual EPS growth rate was 28.10% from 2010 to 2011 and 1.12% from 2011 to 2012. While the most recent years growth rate leaves something to be desired, shareholders should look towards a higher growth in 2013 due to the release of a new Windows operating system and new suite of Office software. MSFT has done a very good job of growing their EPS over the past decade. For 2013, Microsoft has an estimated EPS from Value Line of $2.95. which shows they expect growth to pick back up.
Net Income Growth
Net income has shown the same pattern as EPS from 2002 through 2012. Net Income was 10,384,000,000 in 2002 and grew to 23,171,000,000 in 2012. This gives MSFT a compound annual net income growth rate of 8.36%. More recently MSFT had a net income growth rate of 23.40% from 2010 to 2011 and basically flat net profits from 2011 to 2012. While net income has grown well over the past 10 years, the question for Microsoft becomes how well can they increase profits going forward due to the softening of demand for personal computer products as more consumers turn to Tablets and smart phones for their computing needs.
Sales have been growing for Microsoft over the past 10 years in a consistent uptrend as well. The compound annual growth rate of sales revenues was 10.02%. Sales growth has been fairly in line with net income growth. Both sales and net income has been growing at a considerably slower rate than EPS telling me that EPS is growing at a faster rate due to probable decrease in shares outstanding.
Generally I like to see a decreasing trend or at least a consistent balance in the number of outstanding shares of the company. Since 2003, MSFT’s outstanding share count has been decreasing every single year. With less shares outstanding, the value of each share still available increases. When a company decreases the number of shares available it means the shares I own will have rights to a greater portion of the companies profits.
Return on Equity Trend
When evaluating a company I look for return on equity to be consistently above 12%. Microsoft has had a nice return on equity above 30% since 2006. Maintaining a consistent return on equity shows me that management is doing a good job with shareholders investment.
Current ratio measures a companies ability to meet short term obligations. Microsoft has a 2011 FYE current ratio of 2.6. This means that current assets will be able to cover 260% of current liability obligations. I generally want to see this number be above 1, therefore MSFT passes this test.
Net Profit to Long Term Debt
This number tells me how many years worth of profits it will take to pay off the current long term debt of the company. I like looking at this metric because it gives me an idea of whether the company has taken on too much debt or not. Generally I look for this number to be less then 5 meaning if the company used all their earnings over the next 5 years they could wipe out all debt. For MSFT this net profit to long term debt ratio stands at about 0.46 for 2012. This means Microsoft would be able to pay off all long term debt with about half a years worth worth of profits. It definitely seems like Microsoft is nowhere near being over leveraged.
Dividend Payout Ratio
The dividend payout ratio measures the dividend per share compared to the earnings per share. How much of a companies earnings per share are they paying out to shareholders in the form of a dividend. The past few years MSFT has maintained a dividend payout ratio around 20-30%. This tells me that MSFT is paying out around 30% of profits to shareholders and keeping 70% of profits to grow the company and increase shareholder value through share repurchases. I like this payout ratio because it is fairly low and I don’t believe MSFT should have any trouble maintaining dividend growth in the future even if the company faces struggles near term.
The P/E ratio is a metric I look at to determine if a companies current stock price is too high or within reason. With the most recent closing market price of $26.46 and most recent EPS of $2.72, MSFT has a current P/E right around 9.7. Typically the market P/E average is right around 14 so compared to the market in whole I might determine MSFT to be slightly under valued. However, since MSFT had basically no growth from 2011 to 2012 I believe the market is valuing them lower. Also Microsoft recently reported underwhelming 1st quarter fiscal year 2013 earnings to be disappointing. Depending on whether I believe MSFT can get back on track or not will determine whether I believe this to be a good entry point for an investment in MSFT.
Looking at MSFT’s past P/E ratios of the last few years it looks like they have ranged from a high of 26 to a low of 9. The current P/E of 9.7 is under this range. This could be a chance to get in at a great valuation. Based on the companies performance, I believe the current valuation to be fair depending on your opinion of how personal computer demand will fair going forward..
MSFT had EPS of $2.72 in 2012. The past earnings per share growth rate has been roughly around 27% but we calculated a slower growth rate in sales and net income. Therefore I am going to use a more conservative EPS growth rate of 8% over the next 10 years to figure out what 2022 EPS might look like. This gives me an estimated EPS of $5.87 for MSFT in 2022.
If MSFT is trading at reasonable P/E ratio of 14 in 2022 then it will have a market price of $82.18/share (5.87*14). This will give me an estimated annual growth rate for Microsoft of 12% over the next 10 years. If you would be happy with an 12% return over the next 10 years as well as collecting increasing dividends along the way then MSFT may be a good investment for you. This is a very rough exercise based on growth estimates that may not come to reality. Actual returns in MSFT will vary depending on how well the company increases their earnings and how the market values MSFT in the future.
Based on the above analysis I believe Microsoft to be a good buy at current levels. The future of Microsoft really depends on the strength of the PC market going forward and also how MSFT is able to adapt to changes in technology. MSFT has attempts to enter the strong tablet market with their new Surface as well as with their Windows 8 operating system. Personally I don’t see the downfall of Microsoft as some predict. I believe businesses will always rely heavily on the PC and some may favor Microsoft’s tablet Surface over other tablets due to the ability to use Microsoft Office products which many business rely on. I’m bullish on MSFT going forward and believe this could be a good time to make a buy. The most recent fiscal year earnings as well as the first quarter of their 2013 fiscal year were disappointing causing a fall in the stock. I’m likely to side with analysts who are predicting good earnings for the last 3 quarters of MSFT. This could mean a buy at current prices will prove a great time to get in.
I wanted to do this analysis because I am considering adding to my MSFT position. Personal computer demand going forward is a concern but I believe MSFT will be able persevere. Do you have any thoughts on MSFT or the companies long term earnings prospects? Feel free to share your advice in the comments below.
Disclosure: I have a position in MSFT and am considering adding more shares shortly.
- March 2014 (5)
- February 2014 (8)
- January 2014 (7)
- December 2013 (6)
- November 2013 (7)
- October 2013 (9)
- September 2013 (6)
- August 2013 (7)
- July 2013 (8)
- June 2013 (9)
- May 2013 (8)
- April 2013 (10)
- March 2013 (8)
- February 2013 (9)
- January 2013 (9)
- December 2012 (8)
- November 2012 (8)
- October 2012 (5)
- September 2012 (6)
- July 2012 (2)
- June 2012 (15)
- May 2012 (9)