A previous article examined in some detail Microsoft's Income Statement for the September quarter. Reported earnings were $0.06 more than our $0.56 EPS estimate.
We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value. This post reports on the metrics for Microsoft and the associated financial gauge
scores. The metrics were calculated using data from Microsoft's
current and historical financial statements, including those in the
company's latest 10-Q report.
Before getting into the details, we will take a step back to introduce the subject of today's analysis.
Microsoft develops and sells the operating system software that runs on more than 90 percent of personal computers. It also has dominant application software and server software franchises. In addition, the company provides various online services, such as the Bing search engine and online advertising. Microsoft also sells video game consoles, entertainment devices, and computer peripherals.
Net Income in fiscal 2010 was $18.8 billion, up nearly 30 percent from the prior year. Revenue increased 7 percent, from $58.4 billion in 2008 to $62.5 billion.
The company's market value is presently near $220 billion.
Microsoft is organized into five operating segments: Windows and Windows Live, Server and Tools, Online Services, Microsoft Business, and Entertainment and Devices. The Business Division contributed the most Revenue ($18.9 billion) in 2010, but the Windows Division produced slightly more Operating Income ($12.1 billion). Online Services lost $2.4 billion. Server and Tools did well with Operating Income of $5.0 billion.
A significant proportion of the Windows segment's Revenue is due to the sale of new personal computers on which the equipment manufacturer has installed a version of the company's software. It is, therefore, dependent on the number of personal computers shipped.
With Office 2010 and other products, Microsoft is taking initial steps towards cloud computing to counter competitive threats from Google and others.
Additional
background information about Microsoft and the business environment in
which it is currently operating can be found in the look-ahead.Net Income in fiscal 2010 was $18.8 billion, up nearly 30 percent from the prior year. Revenue increased 7 percent, from $58.4 billion in 2008 to $62.5 billion.
Microsoft is organized into five operating segments: Windows and Windows Live, Server and Tools, Online Services, Microsoft Business, and Entertainment and Devices. The Business Division contributed the most Revenue ($18.9 billion) in 2010, but the Windows Division produced slightly more Operating Income ($12.1 billion). Online Services lost $2.4 billion. Server and Tools did well with Operating Income of $5.0 billion.
A significant proportion of the Windows segment's Revenue is due to the sale of new personal computers on which the equipment manufacturer has installed a version of the company's software. It is, therefore, dependent on the number of personal computers shipped.
With Office 2010 and other products, Microsoft is taking initial steps towards cloud computing to counter competitive threats from Google and others.
In summary, Microsoft's latest quarterly results produced the following changes to the gauge scores:
- Cash Management: 20 of 25 (unchanged from June)
- Growth: 14 of 25 (up from 13)
- Profitability: 20 of 25 (up from 19)
- Value: 17 of 25 (up from 16)
- Overall: 72 of 100 (up from 69)
The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary. Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.
| Cash Management | 30 Sep 2010 | 30 Jun 2010 | 30 Sep 2009 | 5-Yr Avg |
| Current Ratio | 2.3 | 2.1 | 1.8 | 1.9 |
| LTD to Equity | 20.6% | 10.7% | 9.1% | 2.6% |
| Debt/CFO (years) | 0.4 | 0.2 | 0.3 | 0.1 |
| Inventory/CGS (days) | 24.3 | 21.8 | 30.8 | 37.9 |
| Finished Goods/Inventory | 84.0% | 74.6% | 83.0% | 69.8% |
| Days of Sales Outstanding (days) | 57.3 | 62.1 | 64.1 | 62.4 |
| Working Capital/Revenue | 43.1% | 41.6% | 31.8% | 40.8% |
| Cash Conversion Cycle Time (days) | -17.9 | -16.6 | -8.4 | -2.3 |
| Gauge Score (0 to 25) | 20 | 20 | 18 | 18 |
The Cash Management gauge held onto to an admirable 20-point score, even though Debt/Equity ratio has more than doubled in the last year.
The company sold intermediate-term bonds in September 2010 at record low rates. The debt helps Microsoft manage its liquidity across various currencies, and it is a source of funds for dividends and share repurchases.
Microsoft is one of the now-rare U.S. firms with a AAA bond rating.
Ratios related to cash efficiency, such as Days of Sales outstanding, have improved over the last year.
| Growth | 30 Sep 2010 | 30 Jun 2010 | 30 Sep 2009 | 5-Yr Avg |
| Revenue Growth | 16.8% | 6.9% | -8.8% | 8.5% |
| Revenue/Assets | 76.0% | 76.2% | 76.7% | 79.2% |
| Operating Profit Growth | 8.2% | 6.6% | 13.2% | 13.2% |
| CFO Growth | 20.1% | 26.5% | 14.0% | 15.0% |
| Net Income Growth | 49.6% | 28.8% | -22.5% | 12.4% |
| Gauge Score (0 to 25) | 14 | 13 | 5 | 14 |
The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.
The Growth gauge gained another point because Revenue, Cash Flow and Net Income have grown impressively in the last year. For both Revenue and Net Income, the current robust growth rates turned around contractions that were experienced just one year ago.
The Revenue/Assets ratio has not started to expand, which kept the Growth gauge score from advancing further. Proceeds from new debt offerings (discussed above) have increased the company's Assets.
A moderation in the Cash Flow growth rate, relative to three months earlier, also put some downward pressure on the score.
| Profitability | 30 Sep 2010 | 30 Jun 2010 | 30 Sep 2009 | 5-Yr Avg |
| Operating Expense/Revenue | 59.3% | 61.3% | 65.9% | 63.0% |
| ROIC | 167.9% | 124.2% | 112.1% | 157.3% |
| Free Cash Flow/Invested Capital | 201.2% | 151.4% | 150.0% | 180.8% |
| Accrual Ratio | 10.4% | 7.0% | 11.7% | -1.9% |
| Gauge Score (0 to 25) | 20 | 19 | 13 | 16 |
Cost-cutting that began nearly two years ago has had a positive effect on the Microsoft's bottom line.
The ROIC and FCF percentages have soared to figures eye-opening even by Microsoft's standards.
A lower Accrual Ratio, signaling better earnings quality, will be needed for the Profitability gauge to get closer to 25 points.
| Value | 30 Sep 2010 | 30 Jun 2010 | 30 Sep 2009 | 5-Yr Avg |
| P/E | 10.3 | 10.8 | 16.8 | 16.7 |
| P/E vs. S&P 500 P/E | 0.7 | 0.8 | 0.8 | 1.0 |
| PEG | 1.3 | 1.7 | 1.3 | 0.9 |
| Price/Sales | 3.2 | 3.2 | 4.1 | 4.8 |
| Enterprise Value/Cash Flow (EV/CFO) | 6.9 | 7.2 | 9.2 | 11.6 |
| Gauge Score (0 to 25) | 17 | 16 | 14 | 15 |
| Share Price ($) | $24.49 | $23.01 | $25.72 | - |
This combination has resulted in Price/Earnings, Price/Cash Flow, and Price/Sales ratios much less than has historically been the case for Microsoft. The multiples would not be unusual for a staid "value" stock.
The share price is back over $25 since the quarter ended.
| Overall | 30 Sep 2010 | 30 Jun 2010 | 30 Sep 2009 | 5-Yr Avg |
| Gauge Score (0 to 100) | 72 | 69 | 54 | 62 |
The Overall gauge has risen substantially over the last year, and the score remains attractive. The 70-point threshold is tough to cross and sustain because good results are needed in all four gauge categories.
The Growth gauge had been the laggard, but robust revenue growth has led the score upward.
Full disclosure: Long MSFT at time of writing.
Posts
Nice analysis. But for Accrual Ratio, for last 4 quarters shouldn't it be:
ReplyDeleteNet Income = $20,596
CFO = $26,160
CapEx = $2,106
Free Cash Flow = $24,054
Total Assets = $91,540
Accrual Ratio = -3.78%
= ($20,596-$24,054)/$91,540
Please reply with your calculation methodology.
Thanks.
Jeff
Jeff,
ReplyDeleteYour calculations match the way I originally determined the Accrual Ratio. I'm not sure why now, but at some point I changed my spreadsheets to calculate the Accrual Ratio using the Cash Used for Investment instead of Capital Spending. I did not -- but clearly should have -- updated the definition on the web site
=(NetIncome_4Q - CFO_4Q + CUI_4Q) / Total_assets
= (20.596 - 26.160 + 15.072) / 91.54)
= 10.4%
I will see if I can figure out why I changed the equation and if it was a smart thing to do.
I did some further reading on this Accrual Ratio concept and it seems to me that Free Cash Flow provides a more useful comparison. I can't seem to wrap my head around using CUI. Have you looked at this any further yet?
ReplyDeleteHi Jeff,
ReplyDeleteCapital Spending is, as you probably know, one component of Cash Used for Investment. It can be the dominant component for companies that need to build and maintain expense factories and equipment.
CUI includes other investment-related uses of cash. So, we can think of Cash Flow from Ops minus CUI as a variation of Free Cash Flow that will be lower than the tradition CFO minus CS version.
I checked my notes and found that I used this article as a source for accrual ratio info.
http://www.smartmoney.com/investing/stocks/forensic-investing-14529/
Thanks for writing.
Neil