Benjamin Graham was Warren Buffett's professor and mentor at Columbia Business School. Buffett even named his son, Howard Graham Buffett, after Graham. In the preface to Graham's book,"The Intelligent Investor," Buffett calls it "by far the best book about investing ever written."
Serenity's Benjamin Graham Screener applies the 16 financial criteria given by Graham to all 4,700 NYSE and Nasdaq stocks to find defensive, enterprising and NCAV-grade Graham stocks. Today, we will do a complete Graham analysis for Microsoft (NASDAQ:MSFT) and see what grade and price Graham would have recommended for it.
Microsoft Corporation is an American multinational software corporation headquartered in Redmond, Wa., that develops, manufactures, licenses and supports a wide range of products and services related to computing. The company was founded by Bill Gates and Paul Allen on April 4, 1975. Microsoft is the world's largest software maker measured by revenues.
1. A Defensive Analysis:
The first grade of stocks recommended by Graham are called defensive stocks. The criteria that Graham specified for identifying defensive stocks are as follows:
Summarized from Chapter 14 of The Intelligent Investor - Stock Selection for the Defensive Investor:Graham's recommended price for defensive stocks, popularly known as the Graham number, can be calculated from criteria No. 6 and No. 7 as:
1. Not less than $100 million of annual sales.
[Note: This works out to $500 million today based on the difference in CPI/Inflation from 1971]
2-A. Current assets should be at least twice current liabilities.
2-B. Long-term debt should not exceed the net current assets.
3. Some earnings for the common stock in each of the past 10 years.
4. Uninterrupted [dividend] payments for at least the past 20 years.
5. A minimum increase of at least one-third in per-share earnings in the past ten years.
6. Current price should not be more than 15 times average earnings.
7. Current price should not be more than 1-1⁄2 times the book value.
As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.
The publicly available financial figures for Microsoft are as follows:
|Annual Sales||$73,720.00 Million||Reported Book Value||$9.19|
|Current Assets||$85,084.00 Million||Tangible Book Value||$5.93|
|Goodwill||$13,452.00 Million||EPS - Current||$1.94|
|Intangibles||$3,170.00 Million||EPS - Last Year||$2.69|
|Total Assets||$121,271.00 Million||EPS - 2 Years Ago||$2.10|
|Current Liabilities||$32,688.00 Million||EPS - 3 Years Ago||$1.62|
|Long Term Debt||$10,713.00 Million||EPS - 4 Years Ago||$1.87|
|Total Liabilities||$54,908.00 Million||EPS - 5 Years Ago||$1.42|
|Redeemable Preferred Stock||$0.00 Million||EPS - 6 Years Ago||$1.20|
|Non-Redeemable Preferred Stock||$0.00 Million||EPS - 7 Years Ago||$1.12|
|Shares Outstanding||8,381.00 Million||EPS - 8 Years Ago||$0.75|
|EPS - 9 Years Ago||$0.69|
|Assets / Liabilities||130.15%|
|Assets / Debt||489.09%|
|Graham Number / Price||45.99%|
The Graham number works out to $16.09 for Microsoft. Unfortunately, Microsoft misses the dividend record requirement for defensive stocks and so this is not Graham's recommended price for Microsoft.
Let's now take a look at the other grade calculations given by Graham and see if Microsoft meets them.
2. An Enterprising Analysis:
If a stock failed to meet the criteria for defensive investment, Graham recommended the following criteria for enterprising investment.
Summarized from Chapter 15 of The Intelligent Investor - Stock Selection for the Enterprising Investor:This second set of criteria gives us a maximum price for a stock meeting Enterprising conditions as - the lower of 120% net tangible assets (book value), or 10 times current earnings. Microsoft does meet all the Enterprising criteria (except for the price). So Graham's recommended price for Microsoft works out to $7.12 per share.
[Note: For issues selling at P/E multipliers under 10]
1-A. Current assets at least 11⁄2 times current liabilities.
1-B. Debt not more than 110% of net current assets.
2. Earnings stability: No deficit in the last five years covered in the Stock Guide.
3. Dividend record: Some current dividend.
4. Earnings growth: Last year's earnings more than those of 1966.
[Note: This corresponds approximately to the earnings of 2008 today]
5. Price: Less than 120% net tangible assets.
Finally, let's take a quick look at the criteria that Graham recommended for NCAV, net-net or Bargain stocks, and how Microsoft fares against them.
3. An NCAV or Net-Net Analysis:
If a stock met neither Defensive nor Enterprising requirements, Graham recommended the final set of criteria.
Summarized from Chapter 15 of The Intelligent Investor - Stock Selection for the Enterprising Investor:These criteria give us what are called NCAV stocks - stocks selling for less than the value of their cash worth alone, and with positive earnings in the last one year.
"Bargain Issues, or Net-Current-Asset Stocks"
"price less than the applicable net current assets alone - after deducting all prior claims, and counting as zero the fixed and other assets."
"eliminated those which had reported net losses in the last 12-month period."
These are also the most well-known of Graham's stocks, and the source of the popular misconception that Graham only recommended cheap stocks. These were, in fact, the last grade of stocks that Graham recommended.
Microsoft's NCAV price works out to $3.60 and the company has not reported net losses for the last 12 months. But since Microsoft meets all the Enterprising criteria at a higher price, Graham's recommended price for Microsoft remains its Enterprising price.
Microsoft's current price of $34.98 works out to a P/E of 18 and a P/B (tangibles) of 5.89. Since Microsoft does not meet Graham's defensive criteria, but meets the enterprising and NCAV criteria, Graham's recommended price for Microsoft is the enterprising price of $7.12 per share.
However, these results are based on a strict inflation-adjusted Graham analysis. Using more customized strategies, such as those in Tweaking Benjamin Graham's Stock Selection Criteria, would yield higher recommended prices for Microsoft such as a Serenity Number of $11.74, or even the Graham Number of $16.09 itself, if one were willing to overlook the partially met dividend criterion.
Lastly, this analysis should not be construed as a recommendation to short sell Microsoft. Graham never believed in predicting a stock's future price. As far as Graham's principles are concerned, Microsoft may remain at its current or even higher levels indefinitely. Graham simply recommended the prices at which stocks should be bought to avoid losses, and to consistently make profits.
Graham's elaborate criteria, when applied conscientiously to financial data, highlight any discrepancies between stock prices and a company's underlying numbers. Such objective statistical data helps in making informed investment decisions, minimizing losses and identifying unique investment opportunities.
Disclaimer: The results were arrived at by automated quantitative analysis and were not verified manually. Verify the validity of the data used - most importantly, for any recent stock splits - before making an investment decision.