Microsoft (NASDAQ:MSFT) stock has been a rock through this pandemic-driven recession. In early April, I encouraged InvestorPlace readers to buy shares, and since then, it has gained $20. But it’s worth even more moving forward, especially after its first-quarter earnings release.
At the time, I wrote that the company’s massive cash flow was going to power the stock higher. In fact, its free cash flow covers all of the dividends and its share buyback program.
Guess what? The company reported very strong quarterly earnings and cash flow. Like I said before, it is almost like an “anti-recession” stock.
Microsoft Goes From Strength to Strength
For example, Microsoft reported its revenue was up 15%, operating income was up 25%, net income rose 22% and diluted earnings per share gained 23%. These were all year-over-year figures compared to last March.
Moreover, Microsoft generated $13.7 billion in free cash flow during the quarter. That far exceeded the $3.9 billion cost of its dividends as well as the $7.1 billion cost of stock that it bought back in the market.
In fact, on an annualized basis, Microsoft’s FCF works out to $55 billion. This represents 4% of its $1.4 trillion market value. This is truly astounding.
One would normally believe that the law of large numbers would slow down the company’s growth, FCF and its market value. But Microsoft just seems to keep going from strength to strength in this regard.
You can see this in the chart I have prepared. It shows the company’s historical last free cash flow over the trailing 12 months.
Every quarter the LTM FCF seems to be growing, in billions of dollars as well as in percent change from the prior quarter.
One of the company’s key revenue drivers was its Commercial Cloud divisions. Those revenues were up 39% year-over-year. Its Intelligent Cloud business was up 27%. These are powerful drivers for Microsoft’s future.
What Analysts Are Saying About Microsoft Stock
Seeking Alpha has polled 29 analysts who believe earnings for the year ending June will hit $5.69 per share. For next year, 31 analysts believe Microsoft will generate $6.20, up 8.9%. MarketWatch has a similar consensus estimate for next year’s earnings.
That puts Microsoft stock at a healthy 29.6 times price-earnings ratio for next year. This is not cheap. But it is fairly typical for Microsoft, which seems to always have a high P/E ratio.
In fact, in some circles, Microsoft is considered a dependable “value” stock. A huge and very successful pension fund just took a new, big stake in Microsoft, according to Barron’s.
How to Value MSFT Shares
One way to value Microsoft stock is to compare it with similar tech companies its size — over $1 trillion in market value. For example, Amazon (NASDAQ:AMZN) has a FCF yield of 1.6%, compared to Microsoft’s 3.1% LTM FCF yield. Amazon has a $1.2 trillion market value compared to Microsoft’s $1.4 trillion market cap.
Apple (NASDAQ:AAPL) has a $1.4 market value, equal to Microsoft’s. But its LTM FCF yield is 4.6%. Moreover, Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), with its $983 billion market value, has a 2.9% FCF yield.
So, on average, these four stocks sport an average FCF yield of 3.1%. If Microsoft were to trade at that level going forward on a run-rate basis for FCF, the stock will be worth $1.8 trillion ($55 billion divided by 3.1%). That represents a potential increase in the stock market value of 26.7%.
So, on average, Microsoft stock should be trading at $233, on a comparable FCF basis.
The Bottom Line
So far, I can’t see anything that will stop Microsoft’s growing strength, especially in its cash flow. I suspect the stock will do quite well over the next year.
My estimate is that the stock is worth at least 27% more than the present price. Conservative and patient value investors will look to take advantage of this at opportune times.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
