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.) and 2.) above. The stock is trading at a 24.0% discount to its calculated fair value of $44.92. 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 three Stars in this section for 1.), 2.) and 3.) 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%. MSFT earned a Star for having an acceptable score in at least two of the four Key Metrics measured. The company has paid a cash dividend to shareholders every year since 2003 and has increased its dividend payments for 12 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 $23,985. This amount is in excess of the $2,300 target I look for in a stock that has increased dividends as long as MSFT has. If MSFT grows its dividend at 17.5% per year, it will take ine year to equal an MMA yielding an estimated 20-year average rate of 3.41%. MSFT earned a check for the Key Metric 'Years to >MMA' since its one year is less than the five-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 2.5% yield, Oracle Corp. (ORCL) with a 1.5% yield and Google Inc. (GOOG) with a 0.0% yield.
Conclusion: MSFT earned one Star in the Fair Value section, earned three Stars in the Dividend Analytical Data section and earned one Star in the Dividend Income vs. MMA section for a total of five Stars. This quantitatively ranks MSFT as a 5-Star Very Strong stock.
Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $78.12 before MSFT's NPV MMA Differential decreased to the $2,300 minimum that I look for in a stock with 12 years of consecutive dividend increases. At that price the stock would yield 1.4%.
Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $2,300 NPV MMA Differential, the calculated rate is 10.1%. This dividend growth rate is lower than the 17.5% used in this analysis, thus providing a margin of safety. MSFT has a risk rating of 2.00 which classifies it as a Low risk stock.
PC sales have been under pressure for a number of quarters. In addition, MSFT faces a slow recovery in enterprise IT spending. The pending purchase of Nokia's hand set business and the recently announced restructuring, with a new focus on devices and services, should help the company focus and better compete in a challenging marketplace. The company's shift to a mobile strategy and their persistence should eventually lead to long-term success.
With strong free cash flow and very low debt, MSFT in an enviably financial position. Not to be overlooked, the company ended fiscal 2012 with 9 times its dividend in cash and short-term investments sitting on its balance sheet. With its most recent dividend increase, MSFT is a buy below its calculated fair value price of $44.92. I will continue to add to my position in the stock 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 (3.3% of my Dividend Growth Portfolio). See a list of all my dividend growth holdings here.
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