Many investors like to call Microosft (MSFT) a value trap, meaning the stock seems cheap but will never go up. In other words it looks undervalued according to standard metrics as PE but it won’t provide any capital appreciation. Just the dividend, which is not bad at all at 3.3% by the way.
I tend to think the opposite. Microsoft looks cheap and is in fact undervalued. My intrinsic value model gives me a Fair value of around $50, but it could take time to reach it so I will leave that subject for another article.
In this article i just want to show why Microsoft is not a Value trap despite valuation is very attractive at a forward PE of 8.6 and a ttm PE of 10.5 (disregarding the one-time impairment charge the Company took in June). Just for you know, today’s S&P PE is 15. A 33% discount.
Anyway, after you do your analysis and find out the stock is cheap you will wonder if this is or not a value trap case.
I did it myself and analyzed some figures to shed some light to the matter.
The most important thing to have in mind through all the analysis is the one-time Non cash charge Microsoft took last June. This 6 billions charge represents a write-off to a bad investment the Company had done a couple of years ago.
As the expense was a non recurrent one, Non GAAP analysis adjusts Net income for it adding it back. Below is a graph with Net Income figures:
Net income would have been much higher if not for that one-time charge.
Next I want to know which the invested capital as of 31 December is:
Finally, I want to know the return Microsoft if getting from its investments. I would consider a pretty good investment one that yields over 20% a year:
Microsoft is obtaining a 30% return on equity and a 26% return on Invested capital once we take off the June one-time impairment loss.
I don’t know if many people realize this but ROE and ROI above 30% and 25% respectively, is high marks for a Company. It can only be found among excellent business and surely not in non-growing ones.
The general belief is that Microsoft is going nowhere since it’s not as cool as Google or Apple but as we noted above, Microsoft fundamentals are consistently getting better and Valuation is getting worse. This is a matter of time and that’s why I would invest heavily on it with a 3 years time horizon. Dividend yield is at record highs, putting a solid floor to the stock at around 26.5. Risk reward is excellent even being conservative and not taking its fair value into account.
Data Source: Yahoo finance