Why Microsoft Corporation is worth the $1.3 Trillion Valuation
Updated: Jun 2, 2020
Anyone that has used a computer with Windows and Excel and gamed on an Xbox One has experienced a Microsoft interface. Microsoft is one of the oldest technology companies which optimized the use of computers and computer applications to increase efficiency and the utility of technology.
Today, the company's product range is quite spectacular and has started to become even more diversified through the recent developments in cloud services and the acquisition of LinkedIn. Below we can see the revenue breakup of the primary components of Microsoft's business:
Cloud services, which account for 25% of Microsoft's revenue, is an industry that is expected to grow between 17-20% CAGR. Furthermore, the other parts of the firm's business are also growing at a very fast rate, especially the office products and windows sales, which are both services that have few or no other major competitors. At the moment, the company has the 2nd largest market capitalization (~$1.3 Trillion) on the US stock market.
Looking at the management of the company, Satya Nadella, has been rated the 6th best CEO in the United States by Glassdoor, and under his recent leadership the company has more than doubled its return on equity, with dividend gains. Furthermore, Microsoft has proved to be a safe and non-discriminatory place for all employees, clients and stakeholders.
Looking at the company's income statement, it is clear that there is a sustainable growth in revenues, and profits over the last 3 years. The sudden drop in net income in 2018, was caused due to the TSJA registration of the company, which was a tax cost, appointing to around $ 13 billion. I believe this should be counted as a special provision, and not something that should hinder the intrinsic value of this company. Furthermore, it is good to see that the company has been growing its humongous R&D spending, which places it in the top 5 R&D intensive companies in the world.
Looking at the company's balance sheet, it is quite incredible to see the cash holding of this company, with cash equivalents accounting to $ 133 billion. Of the short-term investments mentioned, $ 127 billion are in fixed investments, such US treasuries and bonds. Looking at Microsoft's annual report, they have provided information on how they have spread their debt from repayments in 2020 all the way to debts to be repaid in 2056. Hence, I do not believe the firm would have any problems with these debts, as even the interest repayments can be conducted solely through the interest earned from investments, as seen through the table below.
To top of this liquid balance sheet has a AAA credit rating by S&P and Moody's which makes it one of only two companies in the US to have this credit rating, which is at par with the US treasury!
As value investors, we must be weary of the stock options provided to senior executives, especially in the technology industry. A level of high employee compensation, with little to none growth is a sign of lack of integrity in the management, as described by Benjamin Graham from the 'Intelligent Investor.' However, in the case of Microsoft, at the moment the stock compensation given to executives is far exceeded by the buyback of the company and its profits. As we can see the normal EPS and diluted EPS, are not very different, even if the diluted EPS considers all available stock options.
To conclude, I believe that Microsoft can see fantastic growth potential in its business activities, being in sectors that are either completely dominated by the firm, or in fast growing technology markets. Furthermore, the companies strong balance sheet and investment allow the investor to have trust on the company's short-run standing.