Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk.  This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company or by reviewing the 5 Most Undervalued Companies for the Defensive Investor – July 2015. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.  What follows is a stock analysis showing a specific look at how Microsoft Corporation (MSFT) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Microsoft Corporation is engaged in developing, licensing and supporting a range of software products and services. The Company also designs and sells hardware, and delivers online advertising to the customers. The Company operates in five segments: Devices and Consumer (D&C) Licensing, D&C Hardware, D&C Other, Commercial Licensing, and Commercial Other. The Company’s products include operating systems for computing devices, servers, phones, and other intelligent devices; server applications for distributed computing environments; productivity applications; business solution applications; desktop and server management tools; software development tools; video games; and online advertising. It also offers cloud-based solutions that provide customers with software, services and content over the Internet by way of shared computing resources located in centralized data centers. It provides consulting and product and solution support services.
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Defensive Investor – must pass at least 6 of the following 7 tests: Score = 5/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion -Â PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â PASS
- Earnings Stability – positive earnings per share for at least 10 straight years -Â PASS
- Dividend Record – has paid a dividend for at least 10 straight years -Â PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period -Â PASS
- Moderate PEmg ratio – PEmg is less than 20 -Â FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 -Â FAIL
Enterprising Investor – must pass at least 4Â of the following 5 tests or be suitable for a defensive investor: Score = 5/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 -Â PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 -Â PASS
- Earnings Stability – positive earnings per share for at least 5 years -Â PASS
- Dividend Record – currently pays a dividend -Â PASS
- Earnings growth – EPSmg greater than 5 years ago -Â PASS
Valuation Summary
Key Data:
| Recent Price | $46.40 |
| MG Value | $19.31 |
| MG Opinion | Overvalued |
| Value Based on 3% Growth | $31.27 |
| Value Based on 0% Growth | $18.33 |
| Market Implied Growth Rate | 6.51% |
| NCAV | $3.51 |
| PEmg | 21.51 |
| Current Ratio | 2.50 |
| PB Ratio | 4.71 |
Balance Sheet – June 2015
| Current Assets | $124,712,000,000 |
| Current Liabilities | $49,858,000,000 |
| Total Debt | $27,808,000,000 |
| Total Assets | $176,223,000,000 |
| Intangible Assets | $21,774,000,000 |
| Total Liabilities | $96,140,000,000 |
| Outstanding Shares | 8,137,000,000 |
Earnings Per Share
| 2015 | $1.48 |
| 2014 | $2.63 |
| 2013 | $2.58 |
| 2012 | $2.00 |
| 2011 | $2.69 |
| 2010 | $2.10 |
| 2009 | $1.62 |
| 2008 | $1.87 |
| 2007 | $1.42 |
| 2006 | $1.20 |
| 2005 | $1.12 |
Earnings Per Share – ModernGraham
| 2015 | $2.16 |
| 2014 | $2.46 |
| 2013 | $2.32 |
| 2012 | $2.14 |
| 2011 | $2.12 |
| 2010 | $1.78 |
Dividend History
Free Cash Flow
Conclusion:
Microsoft Corporation qualifies for the Enterprising Investor but not the more conservative Defensive Investor.  The Defensive Investor is concerned with the high PEmg and PB ratios.  The Enterprising Investor has no initial concerns.  As a result, all Enterprising Investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with the evaluation.  As for a valuation, the company appears to be overvalued after growing its EPSmg (normalized earnings) from $2.12 in 2011 to only $2.16 for 2015.  This level of demonstrated earnings growth does not support the market’s implied estimate of 6.51% annual earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value below the price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects.  What do you think?  What value would you put on Microsoft Corporation (MSFT)?  Where do you see the company going in the future?  Is there a company you like better?  Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
Disclaimer:  The author did not hold a position in any company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours.  Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.
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