Even though Microsoft (NASDAQ:MSFT) has a $2.275 trillion market cap, its massive free cash flow (FCF) could push its value even higher. In fact, my calculations show that MSFT stock could trade between 12.6% to 27% higher. Based on its Oct. 14 closing price of $302.75, that puts its value between $340.90 and $384.80 per share.
My forecast is based both on the company’s recent fiscal Q4 earnings and FCF for the year ending June 30, as well as analysts’ forecast for the next two years.
I’ve been consistently positive on MSFT stock in my past articles, especially given how extremely profitable and how high its FCF margins have been. With the company’s latest earnings release, it’s apparent that these high FCF margins will continue. This will lead to a higher target price for MSFT stock.
Higher FCF Leads to Higher Target Price
For the year ending June 30, Microsoft produced $56 billion in FCF, according to the company’s Q4 earnings conference call. Its metrics page shows that cash flow from operations was $76.74 billion for the year ending June 30. After deducting $20.622 billion in capex spending, Microsoft’s free cash flow worked out to $56.118 billion.
This represents 33.4% of its $168.088 billion in revenue for the year to June 30. So we can apply this to analysts’ forecasts for the next two years to forecast future FCF.
For example, analysts surveyed by Seeking Alpha now estimate that revenue for the year to June 2022 will be $191.74 billion. And for the following year, they foresee a 12.88% increase to $216.44 billion.
So if we apply Microsoft’s prior 33.4% FCF margin, we can estimate that FCF will reach $64.04 billion in 2022 and $72.29 by June 2023.
This will help us value MSFT stock going forward.
What MSFT Stock Is Worth
I have shown in past articles that the average FCF yield for Microsoft is about 2.5%. For example, if we divide the $54.118 billion in FCF Microsoft made last year by its $2.275 trillion market capitalization now, the result is 2.378%, not far from a 2.5% FCF yield.
Therefore if we dividend the 2022 FCF estimate of $64 billion by 2.5% the result is a target market cap of $2.562 trillion. That represents a 12.6% gain over today’s market value and implies a target price of $340.90 per share (as I suggest above).
Moreover, using the 2023 FCF estimate of $72.29 billion and dividing it by 2.5% results in a market value estimate of $2.892 trillion. That is 27.1% higher than today and implies a target price of $384.80 per share.
To simplify things, expect to see MSFT stock rise between 13% to 27% higher over the next year. That puts its target price as $384.80 or $2.9 trillion in market value. This is also consistent with what I have forecast in the past when I predicted that Microsoft would reach a $3 trillion market cap.
What to Do With MSFT Stock
This is a very simple model to value Microsoft stock. But sometimes that is all you need, especially with a very profitable and predictable company like Microsoft.
Moreover, sell-side analysts are also very keen on MSFT stock. For example, TipRanks indicates that 20 analysts have an average price target of $339.25 per share. That represents a potential 12% upside for the stock. This is lower than even my minimum expected return of 12.6% for the stock next year.
Similarly, 37 analysts surveyed by Seeking Alpha have an average price target of $335.34 per share. That is still lower than my lowest price target of $340.90 for MSFT stock.
But this is not the whole story. For example, Yahoo! Finance indicates that a number of these analysts have now turned positive on the stock. Many of these analysts maintained their ratings that the stock will outperform going forward in mid-Sept. when the company came out with its latest earnings.
Microsoft comes out with its Q3 earnings on Oct. 26. So now might be a good time for many investors to take initial or larger positions in MSFT stock. This is due to the company’s extraordinarily high level of free cash flow generation and its consistency, as I have shown. This will likely lead to a price between $341 and $385 over the next year.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article, directly or indirectly. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.