Are you risk-adverse and looking to invest in well managed companies with a long history of growth and innovation? Do you like the added bonus of receiving regular dividend payments?
If so, you’re in the right place!
In this series, I present companies with exemplary track records and exciting growth prospects you should seriously consider buying and holding on to for the next decade and beyond.
Today, I will analyze Microsoft Corporation (NASDAQ: MSFT)
Microsoft Corporation (hereinafter referred to as MSFT) is an American multinational technology company who develops, manufactures, licenses, supports, and sells computer software, consumer electronics, personal computers, and related services.
As one of the largest companies in the world, MSFT has successfully developed a very wide economic moat through its brand strength, network effect, switching costs and economies of scale.
Let’s analyze each of these aspects:
- Brand strength: MSFT has over 90,000 total patents. This allows it to exert huge control over the tech market and also generate a lot of cash.
- Network effect: The “phenomenon whereby increased numbers of people or participants improve the value of a good or service“. The fact that millions of people use MSFT products increases the company’s revenues, which allows it to invest and improve the quality and reliability of its products and services.
- Switching Costs: For example, the Microsoft Office software is an industry standard. This implies significant switching costs for consumers: How much time and money would it cost a business to transfer millions of word and excel documents to a different software? Also, how easy is it to work with a word processor that doesn’t accept files in .doc format?
- Economies of scale: Although Amazon dominates the cloud space with 30% of the total market share, MSFT is second with an 11% market share. In fact, MSFT is gaining ground in application workload as Azure holds 29.4% of the installed base. Cloud services contribute to economies of scale by allowing core infrastructure to be brought into large data centers. This leads to supply-side savings (large-scale data centers lower costs per server), demand-side aggregation (aggregating demand for computing smooths overall variability, allowing server utilization rates to increase), and multi-tenancy efficiency (a multitenant application model increases the number of tenants and lowers the application management and server cost per tenant).
Individually, these elements are competitive advantages. Collectively, they form an almost impenetrable moat. In sum, MSFT is a very mature business who still has plenty of room to grow in the coming years.
Analyzing the company’s finances will demonstrate just how solid of an investment MSFT is.
1 – REVENUES & PROFITABILITY
MSFT is very successful at generating revenues and controlling its costs:
- 2016-2019: Revenues increased 47.49%
- 2016-2019: Net Income increased 133.59%
- 2016-2019: EBITDA increased 110.22%
Note: In the tech space, investments in R&D are crucial to developing new products and staying innovative. Thus, it is reassuring to note that in 2019, MSFT invested $16.8 billion in R&D (13% of the firms total revenues). Investment in R&D increased 40.77% between 2016-2019.
As mentioned above, MSFT’s profit margins are incredibly robust:
- 2015-2019 average annual Gross Margin of 64.8% is very good
- 2015-2019 average annual Net Profit Margin of 21.5% is good
- 2015-2019 average annual Net EBITDA Margin of 38.7% is good
In addition to having consistently high margins, MSFT’s returns on assets, investments and equity are consistently good:
- 2015-2019 average annual ROE of 26.5% is good
- 2015-2019 average annual ROA of 9.5% is decent
- 2015-2019 average annual ROI of 15.42% is good
In sum, MSFT’s management is doing a good job of generating revenues, controlling its costs and using its assets to generate returns.
2 – ASSETS, DEBTS & CASH FLOW
In 2019, MSFT boasted an incredible $175.5 billion in assets.
Between 2016-2019, the company’s total assets increased 47.9%.
MSFT has a seemingly significant debt burden, with $66.6 billion of long term debt. Between 2016-2019, its total long term debt increased 63.4%.
MSFT’s Current Ratio is 2.5 which is excellent.
MSFT’S Debt to Equity Ratio is 1.8 which is poor.
MSFT’S Debt Ratio is 0.64. which is good.
While the company’s long term debt burden is significant, it must be noted that it is almost entirely covered by a single year of EBITDA, which means that the company could theoretically almost pay off the majority of its debt if it needed to.
- CASH FLOW
Lastly, it’s important to highlight the fact that MSFT is incredibly effective at generating cash flow. Its 2019 Free Cash Flow of $38 billion represents growth of 53% from 2016 levels.
In sum, while MSFT is increasing its liabilities at a faster rate than its assets, its overall debt ratio is favorable. Furthermore, MSFT’s ability to generate massive EBITDA and Free Cash Flow significantly offset the debt burden.
3 – THE DIVIDEND
With a dividend yield of 1.39% and an annual payout of $2.04 per share, MSFT is far from being the most lucrative dividend stock you can purchase.
Also, the payout ratio of 36% is rather low. This indicates that the company prefers investing its earnings over distributing them to shareholders, which is actually good for the company’s long term future.
Even with the stock price’s recent dip, the current dividend yield of 1.39% is below the 4-year average of 1.92%. This indicates that the company’s dividend growth is not on par with the stock price’s appreciation. This indicates that the stock may be overvalued.
While the dividend yield is modest, the dividend’s 10-year growth rate of 13.77% is reasonable. However, this appears low when you compare the stock price’s average annual growth rate of 42% over the same period.
In sum, MSFT’s dividend is modest but is growing at a reasonable rate.
4 – CONCLUSION
Microsoft is an exceptionally well managed company with a proven track record of success. While past performance is no guarantee of future success, we can conclude the following:
- MSFT is growing its revenues and controlling its costs,
- MSFT is generating substantial profits and massive cash flow,
- MSFT’s management is investing heavily in R&D,
- The company’s debt burden is under control,
- Management is generating good returns on investments,
- The dividend is modest but growing at a reasonable rate,
- Given the stock price’s past performance, future capital gains are potentially significant,
VERDICT: STRONG BUY.