MSFT: Gauge Analysis (updated February 22, 2021)

I have analyzed Microsoft's financial statements to determine whether the company's shares can be considered a good value and reasonable risk for prudent investors. My analytical approach was inspired by Benjamin Graham's recommendations in "The Intelligent Investor," which was first published in 1949 and is still one of the best-known books about value investing. I modified Graham's specific suggestions to fit modern times; however, the goal is the same: find stocks that are inexpensive relative to the company's strengths and aren't excessively risky.

The analysis uses gauges to assess how well the company satisfies seven specific investment criteria.  GREEN, YELLOW, and RED grades indicate whether the criteria are fully satisfied, partially satisfied, or not satisfied.  An Overall Score between zero and 100, which takes all gauges into account, is also computed.  While the analysis includes both growth and value criteria, the Overall Score calculation by design favors companies with good value characteristics over fast-growing, but expensive firms.  An Overall Score above 60 signifies the company is worth examining in more detail; a score over 80 is a rare accomplishment.

First, a quick review of the company itself.

Microsoft develops and sells operating system and application software, software and cloud services, and hardware items, such as game consoles. Cloud computing has become a large and growing business for Microsoft, and the company competes with industry leader Amazon, Google, and others. Microsoft acquired LinkedIn in December 2016 for approximately $27 billion, and it acquired GitHub in October 2018 for $7.5 billion. In September 2020, Microsoft reached an agreement to acquire ZeniMax Media, the parent company of game-developer Bethesda Softworks, for $7.5 billion.

Microsoft recorded profits of $51 billion on revenue of $153 billion during the last year. In the quarter that ended on December 31, 2020, Microsoft earned $2.03 per share, which significantly beat the $1.64 Wall Street consensus forecast. See Microsoft's most recent quarterly report.

Shares of Microsoft now trade for about $240 each, giving the company a market value of $1.8 trillion. These shares can be found in the Dow Jones Industrial Average, Standard and Poors 500, Standard and Poors 100, NASDAQ 100, and Russell 1000 stock indices.

Analysis Results:

Microsoft's grades on the seven investment criteria are listed below, along with some of the financial figures that influenced these color assignments

1. The Company's Size is Substantial: GREEN

    Market Value: $1.8 trillion (mega-cap)

2. The Company is Conservatively Financed: GREEN

    Current ratio = 2.6 (>2.0 is conservative)

    Long-term debt/Working Capital = 52% (<150% is conservative)

3. The Company Generates Stable Earnings: GREEN

    Nineteen positive quarterly earnings reports in last 5 years (almost perfect)

    Earnings variability = 1% (negligible)

4. The Company Exhibits Earnings Growth: GREEN

    Owner Earnings growth rate (trailing year) = 27% (very good)

    Owner Earnings growth rate (five-year average) = 28% (very good)

    Free Cash Flow growth rate (trailing year) = 24% (very good)

    Free Cash Flow growth rate (five-year average) = 15% (good)

5. The Company is Efficiently Profitable: GREEN

    Cash Flow Return On Invested Capital = 37% (excellent)

    Operating Profit/Sales = 39.2% (excellent)

6. The Company Pays a Healthy Dividend: GREEN

    Dividends paid for the last 7 years or longer

    Dividend 5-year average growth rate = 9% (fair)

    Dividend = 32% of last year's FCF (easily sustainable with room to grow)

7. The Company's Shares are Fairly Valued: RED

    Price/Owner Earnings (last year) = 40.4 (very expensive)

    Price/GAAP Earnings (five-year average) = 57.5 (expensive)

    Free Cash Flow/Market Value = 2.7% (low, less than the five-year average of 4.4%)

    Acquirer's Multiple = 29.3 (very expensive)

    Price/Book Value = 14.1 (more expensive than the five-year average of 9.1)

    Price/Sales = 12.0 (more expensive than the five-year average of 7.4)

In summary, the analysis assigned Microsoft six GREEN, zero YELLOW, and one RED grades.  The resulting Overall Score is 54 of the 100 possible points, which is not high enough.  The score is below the 60-point GCFR threshold, and, therefore, Microsoft does not satisfy the GCFR criteria for investment consideration at this time.

The share price would theoretically have to fall by 41%, from $241 to $142, all else being equal, to lift the Overall Score to the 60-point threshold. It is also possible that Microsoft's future results will push the score up (or pull it down).  Revisit GCFR2 occasionally for updates on Microsoft's performance and the latest GCFR gauges and scores.

This analysis reported here is a limited evaluation of the subject company.  It does not consider all material facts about the company's operations, finances, or future prospects.  The analysis relies on publicly available financial data assumed, but not guaranteed, to be accurate and consistent.  Readers are strongly encouraged to verify all data and perform their own independent analyses.  Other analytical approaches and screening criteria will be more applicable to investors having different goals, circumstances, and tolerance for investment risk.  This post is not and should not be considered investment advice, nor does it constitute an offer or solicitation to buy or sell any security. The author might have a long or short position in the subject company and/or its competitors. The analytical approach, the criteria used, and all calculations are subject to change without notification.

---------------

 #microsoft    #msft    #gauges  #gcfr  #gcfr2 #valueinvesting   #nac_financialanalysis

MSFT: Earnings Report for the Quarter Ending December 31, 2020

Microsoft reported after the market closed on January 26, 2021 it earned $2.03 per diluted share in the quarter that ended on December 31, 2020, up 33 percent from earnings of $1.53 in the same 3 months of the previous year. These figures are the earnings determined in accordance with U.S. Generally Accepted Accounting Principles (GAAP). 

This post compares the quarterly Income Statement published by Microsoft to the estimates I made in a previous “Look Ahead” post.  My estimates were based on publicly available guidance provided by Microsoft's management to financial analysts, news reports, and trends in the company's historical results.  Unless otherwise mentioned, all reported values mentioned below are GAAP figures.

First, a little background about the company:  Microsoft develops and sells operating system and application software, software and cloud services, and hardware items, such as game consoles. Cloud computing has become a large and growing business for Microsoft, and the company competes with industry leader Amazon, Google, and others. Microsoft acquired LinkedIn in December 2016 for approximately $27 billion, and it acquired GitHub in October 2018 for $7.5 billion. In September 2020, Microsoft reached an agreement to acquire ZeniMax Media, the parent company of game-developer Bethesda Softworks, for $7.5 billion.

Revenue in the December 2020 quarter totaled $43.1 billion, 17 percent more than last year's $36.9 billion. The Productivity and Business Processes business was responsible for 31 percent of overall revenue, and this unit's revenue grew by 12.9 percent compared to the year-earlier result. The Intelligent Cloud business contributed 34 percent of revenue, and this unit's revenue increased by 23.0 percent. The More Personal Computing unit supplied 35 percent of revenue, and this business's revenue rose by 14.5 percent.

I was expecting Microsoft to report revenue of $40.0 billion for the December 2020 quarter.  The actual amount surpassed my estimate by $3076.0 million (7.7 percent).

The Cost of Revenue (also known as Cost of Goods Sold) was $14.2 billion in the latest quarter, which translates into a Gross Margin of 67.0 percent of revenue. Since it was higher than the 66.5 percent Gross Margin achieved in the year-earlier quarter, it signifies that Microsoft sold its products and services at more profitable prices relative to production costs. I was expecting the Gross Margin to be 65.4 percent in the December 2020 quarter, and Microsoft exceeded that prediction by 1.7 percent.

Microsoft spent $4.9 billion on Research and Development in the latest quarter, up from $4.6 billion one year ago. I had estimated that R&D expenses would be $5.0 billion.  R&D was 11.4 percent of Revenue.

Sales, General, and Administrative expenses totaled $6.1 billion in the December 2020 quarter, up from $6.1 billion one year ago.  SG&A expenses decreased from 16.4 percent to 14.1 percent of quarterly revenue, which shows Microsoft spent less per dollar of sales on indirect operational costs, such as marketing. I had estimated that SG&A expenses would be 16.1 percent of revenue, and Microsoft spent less than that percentage.

Operating Income was $17.9 billion in the quarter, up 28.8 percent from the year-earlier period.  Operating Income exceeded my $14.7 billion estimate by $3.2 billion.

Interest and other non-operating items summed to a net  income of $440 million.  My estimate was $0.0 million.

The effective income tax rate fell by 1.6 percent to 15.7 percent, which had a positive effect on net income.  I expected the tax rate to be 16.0 percent.

Net income in the quarter was $15.5 billion, $2.03 per share.  The figures for the year-earlier quarter were $11.6 billion, $1.53/share. My EPS estimate was $1.62.

In summary, Microsoft's earnings were much better than I expected.  The major factors that resulted in this achievement were: strong revenue growth, an improved Gross Margin, reduced R&D spending, lower SG&A/revenue ratio, and non-operating income.

The Cash Flow Statement for the quarter shows that Microsoft's operating activities generated $12.5 billion in cash during the last quarter, up 17.2 percent from $10.7 billion in the year-earlier period. The cash flow delta was, therefore, less robust the change in earnings. Notable uses for cash included $4.2 billion to pay dividends to shareholders, $415 million for corporate acquisitions,$6.5 billion to buy back the company's common shares, and $4.2 billion to acquire property, plant and capital equipment. 

Free cash flow over the last 12 months totaled $50.5 billion, or $6.63 per share using the latest share count. At the current market price per share of $232.33, this translates into a modest Free Cash Flow Yield of 2.9 percent.

This post is not investment advice, and the accuracy of the information, tables, charts, and any commentary presented is not guaranteed.  Readers are encouraged to independently verify all data using information from original sources. The Income Statements discussed in these blog posts have not been audited and may differ in material respects from those published by the subject company.  These differences are intended to facilitate analysis and cross-company comparisons. Complete financial statements with notes can usually be found in the 10-Q and 10-K filings companies submit to the Securities and Exchange Commission (SEC).

 #microsoft    #msft    #gauges  #gcfr  #gcfr2 #QtrlyRpt   #nac_financialanalysis

MSFT: Look Ahead to December 2020 Quarterly Results

This "look-ahead" post discusses how I came up with an estimate for Microsoft's earnings for fiscal 2021's second quarter, which ended on December 31, 2020, by predicting each element of its Income Statement, from top-line Revenue to bottom-line Earnings Per Share (EPS) and everything in between. 

Once the company’s official results become available on January 28, I will compare the published Income Statement to the prediction and identify any surprises, positive or negative.  Examining these differences can identify what factors (e.g., profit margins, non-GAAP expenses, tax rates, share buybacks) are driving changes to a company's financial performance.

But, before we get into the details, let's take a step back and start with background information about Microsoft.

Microsoft develops and sells operating system and application software, software and cloud services, and hardware items, such as game consoles. Cloud computing has become a large and growing business for Microsoft, and the company competes with industry leader Amazon, Google, and others. Microsoft acquired LinkedIn in December 2016 for approximately $27 billion, and it acquired GitHub in October 2018 for $7.5 billion. In September 2020, Microsoft reached an agreement to acquire ZeniMax Media, the parent company of game-developer Bethesda Softworks, for $7.5 billion.

Shares of Microsoft now trade for about $222 each.  These shares can be found in the Dow Jones Industrial Average, Standard and Poors 500, Standard and Poors 100, NASDAQ 100, and Russell 1000 stock indices.

Microsoft recorded profits of $47 billion on revenue of $147 billion during the last year. In the quarter that ended on 30 September 2020, Microsoft earned $1.82 per share, which significantly beat the $1.54 Wall Street consensus forecast. See http://tinyurl.com/yxosq5h4 for Microsoft's most recent quarterly report.

Revenue in the September 2020 quarter totaled $37.2 billion, 12% more than last year's $33.1 billion. The Productivity and Business Processes business was responsible for 33% of overall revenue, and this unit's revenue grew by 11.2% compared to the year-earlier result. The Intelligent Cloud business contributed 35% of revenue, and this unit's revenue grew by 19.7%. The More Personal Computing unit supplied 32% of revenue, and the amount grew by 6.4%.

My starting point, if available, when estimating earnings is guidance provided by the company's management to financial analysts.  It's true that the company may downplay expectations somewhat to avoid disappointments, but the top managers ought to know better than anyone else how well their products and services are selling.  I also look for other information about the company in the news, and I take advantage of trends in the company's historical results.  While it makes my task a little more difficult, I also try to estimate earnings that conform to Generally Accepted Accounting Principles (GAAP).  Non-GAAP results, which most professionals focus on, are somewhat arbitrary and often exclude meaningful items.

Microsoft's management communicated their expectations for the December 2020 quarter last October.  (It would have been nice if they had made this easier to find by including it in an 8-K.)

The guidance indicates that the company expects Revenue between $39.5 and $40.4 billion, Costs of Goods Sold between $13.75 and $13.85 billion, and other operating expense (i.e., Research and Development, plus Sales, General, and Administrative expenses) between $11.4 and $11.5 billion.  

The following baseline Income Statement takes into consideration the information mentioned above and trends seen in the company's historical results. The bottom line is that estimated earnings are $12.35 billion ($1.62 per share).

Please note that my organization of revenues, expenses, gains, and losses, which I use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

 #microsoft  #msft  #gauges #gcfr  #gcfr2 #lookahead #nac_financialanalysis

Microsoft's Quarterly Earnings Report

Microsoft reported (tinyurl.com/yxosq5h4) after the market closed on 27 October 2020 it earned $1.82 per diluted share in the quarter that ended on 30 September 2020, up 32% percent from earnings of $1.38 in the same 3 months of the previous year. These figures are the earnings determined in accordance with U.S. Generally Accepted Accounting Principles (GAAP). 

Microsoft develops and sells operating system and application software, software and cloud services, and hardware items, such as game consoles. Microsoft acquired LinkedIn in December 2016 for approximately $27 billion, and it acquired GitHub in October 2018 for $7.5 billion.  In September 2020, Microsoft reached an agreement to acquire ZeniMax Media, the parent company of game-developer Bethesda Softworks, for $7.5 billion.

Earnings of $1.82 per share in the latest quarter significantly beat the $1.54 average ("consensus") of estimates made by Wall Street analysts. See tinyurl.com/y66ln98g for Microsoft's earnings record and forecasts.

Although Microsoft's earnings were better than expected, stock market traders still weren't satisfied. The price of the company's shares fell 1.8% during after-hours trading following the report.

Note that a change in the assumed useful life of Microsoft's servers and network equipment increased net income in the quarter by $927 million, or $0.10 per share.

Looking deeper into the GAAP results, "top-line" revenue in the September 2020 quarter totaled $37.2 billion, 12% more than last year's $33.1 billion. The Productivity and Business Processes business was responsible for 33% of overall revenue, and this unit's revenue grew by 11.2% compared to the year-earlier result. The Intelligent Cloud business contributed 35% of revenue, and this unit's revenue grew by 19.7%. The More Personal Computing unit supplied 32% of revenue, and the amount grew by 6.4%.

The gross margin strengthened from 68.5% of revenue to 70.4%, a sign that Microsoft sold its output and services at more profitable prices relative to production costs. Sales, general, and administrative expenses decreased from 16.3% to 14.4% of quarterly revenue, which shows the company spent less per dollar of sales on other operational costs, such as marketing. The effective income tax rate fell by 2.0% to 13.8%, which had a positive effect on net income.

Microsoft's operating activities generated $19.3 billion in cash during the last quarter, up 39.9% from $13.8 billion in the year-earlier period. The cash flow delta was, therefore, much better than the change in earnings. Notable uses for cash included $3.9 billion to pay dividends to shareholders, $481 million for corporate acquisitions, $6.7 billion to buy back the company's common shares, and $4.9 billion to acquire property, plant and capital equipment. 

Free cash flow over the last 12 months totaled $49.3 billion, or $6.45 per share using the latest share count. At the current market price per share of $202.47, this translates into a modest Free Cash Flow Yield of 3.2%.

The accompanying charts illustrate several trends in Microsoft's financial results, taken from data in regulatory filings. The text and the charts are intended to provide some limited historical context for readers interested in the company’s finances. No investment advice is provided, and no investment offer of any kind is made or solicited. The accuracy of the information presented is not guaranteed, and readers are encouraged to independently verify all data.

#microsoft    #msft    #earnings    #nac_financialanalysis