Stock Analysis

Microsoft Corporation (NASDAQ:MSFT) Will not be Taken Private, But it Might go to US$420

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Some companies manage to keep on the positive momentum, even after growing to an astonishing size. One such example is Microsoft Corporation (NASDAQ: MSFT), which just delivered another quarter of solid performance for its investors.

In this article, we will look at the latest catalysts and examine the company's value through a discounted cash flow (DCF) analysis.

Check out our latest analysis for Microsoft

Earnings Results

  • Non–GAAP EPS: US$2.27 (beat by US$0.19)
  • GAAP EPS: US$2.71 (beat by US$0.64)
  • Revenue: US$45.3B (beat by US$1.3b)
  • Revenue Growth: +21.8% Y/Y

The company announced an expansion to the relationships with Fidelity National Information Services (NYSE: FIS) WorldPay, which will provide online credit and debit card processing for Microsoft's online store operations. This expansion is building on the already successful collaboration in LATAM since 2014.

Furthermore, the company recently announced a US$60b extension to the share buyback program and raised the dividend from US$0.56 to US$0.62, an 11% increase. This marks the 15th consecutive year of dividend increases.

These decisions reflect the optimism within the company as there are multiple positive catalysts within the company:

  • All 3 business segments are experienced yearly growth – there are no laggards
  • Cloud sales are excellent, with the Azure platform climbing 50% y/y
  • Xbox cloud gaming is expanding while videogame industry sales are booming
  • Initial Windows 11 reviews are positive

Our Take on Microsoft's Intrinsic Value

We'll do a simple run-through of a valuation method used to estimate the attractiveness of Microsoft as an investment opportunity by taking the expected future cash flows and discounting them to today's value.

The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Remember, though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

The model

We're using the 2-stage growth model, which means we take into account two stages of the company's growth. In the initial period, the company may have a higher growth rate, and the second stage is usually assumed to have a stable growth rate.

To start with, we need to estimate the next ten years of cash flows. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than in later years.

Generally, we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$60.7b US$68.4b US$81.6b US$98.5b US$120.3b US$136.5b US$150.1b US$161.5b US$171.0b US$179.0b
Growth Rate Estimate Source Analyst x16 Analyst x12 Analyst x5 Analyst x4 Analyst x3 Est @ 13.42% Est @ 9.99% Est @ 7.58% Est @ 5.89% Est @ 4.71%
Present Value ($, Millions) Discounted @ 6.3% US$57.1k US$60.6k US$68.0k US$77.3k US$88.8k US$94.8k US$98.1k US$99.4k US$99.0k US$97.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$841b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case, we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth.

In the same way, as with the 10-year "growth" period, we discount future cash flows to today's value, using a cost of equity of 6.3%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$179b× (1 + 2.0%) ÷ (6.3%– 2.0%) = US$4.2t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.2t÷ ( 1 + 6.3%)10= US$2.3t

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$3.2t. In the final step, we divide the equity value by the number of shares outstanding. Relative to the current share price of US$310, the company appears a touch undervalued at a 26% discount to where the stock price trades currently. Valuations are imprecise instruments, do keep this in mind.

NasdaqGS: MSFT Discounted Cash Flow October 27th, 2021

Important assumptions

We would point out that the most critical inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. The DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a complete picture of a company's potential performance.

Given that we are looking at Microsoft as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which accounts for debt. We've used 6.3% in this calculation, which is based on a levered beta of 0.981. Beta is a measure of a stock's volatility compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, a reasonable range for a stable business.

Moving On:

Valuation is only one side of the coin in building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation.

While Microsoft has a number of positive developments, indicating there is more good news down the road, we've put together three important aspects you should further examine:

  1. Risks: For example, we've discovered 2 warning signs for Microsoft that you should be aware of before investing here.
  2. Future Earnings: How does MSFT's growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock, search here.

Valuation is complex, but we're helping make it simple.

Find out whether Microsoft is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

Stjepan Kalinic

Stjepan Kalinic

Stjepan is a writer and an analyst covering equity markets. As a former multi-asset analyst, he prefers to look beyond the surface and uncover ideas that might not be on retail investors' radar. You can find his research all over the internet, including Simply Wall St News, Yahoo Finance, Benzinga, Vincent, and Barron's.

About NasdaqGS:MSFT


Microsoft Corporation develops, licenses, and supports software, services, devices, and solutions worldwide.

Flawless balance sheet with acceptable track record.