A previous GCFR article examined in some detail Microsoft's Income Statement for the December quarter. Reported earnings were a substantial $0.10 per share better than our $0.67 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.
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 2009 to $62.5 billion.
Microsoft is included in the Dow Jones Industrial Average and the S&P 500. The company's share price has for many years been between $20 and $30, with occasional excursions outside the range. The share price is now in the upper half of the range, which translates into a market value of approximately $240 billion on a fully diluted basis.
Microsoft successfully launched Windows 7 in October 2009 and followed it up with Office 2010 in June 2010. The company sold 300 million Windows 7 licenses in the first 15 months after the launch date.
A significant proportion of Windows revenue results from the sale of new personal computers on which the equipment manufacturer has installed the latest software. Research firm Gartner reported that PC shipments increased in 2010, but the pace disappointed in the fourth quarter. The research firm attributed slowing sales to competition from tablet computers, such as the iPad, and other consumer electronic devices. Business spending on PCs has been stronger than consumer spending, and emerging markets have generated more robust sales than developed regions.
With Office 2010 and other products, Microsoft is taking initial steps towards cloud computing to counter a threat from Google and others.
Now we turn to the financial gauges. The latest quarterly results produced the following changes to the scores:
- Cash Management: 19 of 25 (down from 20 in September)
- Growth: 11 of 25 (down from 14)
- Profitability: 17 of 25 (down from 20)
- Value: 12 of 25 (down from 17)
- Overall: 58 of 100 (down from 73)
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 | 31 Dec 2010 | 30 Sep 2010 | 31 Dec 2009 | 5-Yr Avg |
| Current Ratio | 2.5 | 2.3 | 2.0 | 1.9 |
| LTD to Equity | 19.9% | 20.6% | 8.5% | 3.7% |
| Debt/CFO (years) | 0.4 | 0.4 | 0.3 | 0.1 |
| Inventory/CGS (days) | 20.7 | 24.3 | 25.1 | 37.2 |
| Finished Goods/Inventory | 76.2% | 84.0% | 81.2% | 69.3% |
| Days of Sales Outstanding (days) | 61.2 | 57.3 | 63.6 | 62.6 |
| Working Capital/Revenue | 46.0% | 43.1% | 35.2% | 39.4% |
| Cash Conversion Cycle Time (days) | -10.9 | -17.9 | -15.1 | -2.4 |
| Gauge Score (0 to 25) | 19 | 20 | 19 | 18 |
The Cash Management gauge slipped a single point to 19, still a very good score. The gauge reacted negatively to the rise from last quarter in the number of Days of Sales Outstanding, which is related Accounts Receivable.
Although Long-term Debt/Equity has more than doubled in the last year, other measures clearly show the debt is insignificant. Most notably, Microsoft has over $40 billion in cash and short-term investments, more than 4 times the company's total debt. In addition, the debt is less than the company's average Cash Flow from Operations in two quarters.
The debt helps Microsoft manage its liquidity across various currencies, and it is a source of funds for dividends and share repurchases.
After the quarter ended, Microsoft sold an additional $2.25 billion in notes maturing between 2016 and 2041. This doesn't change the conclusion about the significance of the debt.
| Growth | 31 Dec 2010 | 30 Sep 2010 | 31 Dec 2009 | 5-Yr Avg |
| Revenue Growth | 13.6% | 16.8% | -5.3% | 9.0% |
| Revenue/Assets | 76.5% | 76.0% | 79.4% | 80.9% |
| Operating Profit Growth | 8.3% | 11.7% | 12.8% | 14.4% |
| CFO Growth | 21.1% | 20.1% | 3.2% | 13.1% |
| Net Income Growth | 26.5% | 49.6% | -5.7% | 13.0% |
| Gauge Score (0 to 25) | 11 | 14 | 2 | 14 |
The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.
The Growth gauge slipped three points primarily because Revenue's trailing-year growth rate slowed, which was to be expected since the boost from the Windows 7 launch has receded into the prior year.
Net Income growth also eased from last quarter's lofty 50 percent, but the latest rate, 26.5 percent is still impressive. Operating Profit, which we average over a longer, 4-year period contracted.
The Cash Flow growth rate continued to expand,
The Revenue/Assets ratio is lower than it was last year, which was a negative for the Growth gauge score. Proceeds from new debt offerings (discussed above) have increased the company's Assets.
| Profitability | 31 Dec 2010 | 30 Sep 2010 | 31 Dec 2009 | 5-Yr Avg |
| Operating Expense/Revenue | 60.4% | 59.3% | 62.8% | 62.9% |
| ROIC | 128.9% | 167.9% | 108.4% | 125.8% |
| Free Cash Flow/Invested Capital | 149.0% | 201.2% | 124.6% | 142.5% |
| Accrual Ratio | 12.7% | 10.4% | 12.7% | 0.7% |
| Gauge Score (0 to 25) | 17 | 20 | 15 | 16 |
The Profitability Gauge gave back three points, primarily because there wasn't more of a reduction in Operating Expenses as a percentage of Revenue.
Cost-cutting that began two years ago has had a positive effect on the Microsoft's bottom line.
Microsoft's hoard of cash and short-term investments is excluded from Invested Capital, which boosts the ROIC and FCF ratios. Both percentages have returned to levels near, but above, their five-year averages.
A lower Accrual Ratio would signal better earnings quality. This would be more likely if Cash Flow were to grow at a faster pace than Net Income.
| Value | 31 Dec 2010 | 30 Sep 2010 | 31 Dec 2009 | 5-Yr Avg |
| P/E | 11.6 | 10.3 | 16.8 | 16.2 |
| P/E vs. S&P 500 P/E | 0.8 | 0.7 | 0.9 | 0.9 |
| PEG | 1.4 | 0.9 | 1.3 | 1.0 |
| Price/Sales | 3.6 | 3.2 | 4.6 | 4.6 |
| Enterprise Value/Cash Flow (EV/CFO) | 8.2 | 6.9 | 11.6 | 12.2 |
| Gauge Score (0 to 25) | 12 | 17 | 9 | 14 |
| Share Price ($) | $27.91 | $24.49 | $30.48 | - |
However, several of the multiples still appear favorable when they are compared to their levels of one year ago or to their long-term averages. A below-12 P/E hardly seems expensive, even if it was less earlier in 2010.
The EV/CFO ratio may bear watching. If we invert it, the ratio indicates Microsoft's Cash Flow from Operations during the last year was more than 12 percent of its Enterprise Value at the end of the year. This is not a bad return, especially when Cash Flow has grown at a healthy rate over the years.
| Overall | 31 Dec 2010 | 30 Sep 2010 | 31 Dec 2009 | 5-Yr Avg |
| Gauge Score (0 to 100) | 58 | 73 | 47 | 62 |
The Overall gauge had a superlative score over 70 points in June and September when Microsoft's share price was $23 and $24.50, respectively. The score is not so lofty now that the price is back in the top half of the $20 to $30 range. However, a 58-point score is a very respectable result, better than most companies achieve. It's also positive that each of the category gauges remains over 10 points, led by the Profitability gauge's 17 points.
Full disclosure: Long MSFT at time of writing.
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