How Much is Microsoft Worth?

Last week, Microsoft ($MSFT) finally delivered a decent earnings number. The company earned 76 cents per share which was a penny ahead of expectations. The quarter before that, MSFT missed by three cents per share, and Wall street was not pleased.

Microsoft’s fiscal year ends in June, and the company is on track to earn about $2.85 per share, give or take. But the stock is only up to $27.85 going by yesterday’s close, and that’s after a small rebound. MSFT certainly has its problems, but I would think the world’s largest software outfit could command a P/E Ratio greater than 10.

Here’s a look at Microsoft’s stock and earnings over the past few years. The stock is the blue line and it follows the left scale. The earnings are in black and they follow the right scale. I scaled the two lines at a ratio of 10-to-1 so whenever the lines cross, the stock’s earnings multiple is exactly 10. The red line is Wall Street’s earnings projections.

The stock gapped up between November 2011 and March 2012 and investors expected an earnings rebound. It didn’t come. If — and this is a strong if — Wall Street’s earnings forecast is correct, MSFT’s stock should rebound this year. And that’s going by very modest valuations.

To get a good idea of what a fair value is for Microsoft, let’s look at my “world’s simplest stock valuation measure.” The equation is:

Growth Rate/2 + 8 = PE Ratio

For Microsoft, the expected five-year earnings growth rate is 8.38%. The calendar year 2013 earnings estimate is $3.16 per share. That gives us a fair value of $38.52 which means the stock is 28% undervalued.

Please bear in mind that my little equation isn’t a precise measure of true value. It’s a ballpark guideline of what might be a good value. What it really tells us is that investors don’t like Microsoft and they’re steering clear of it, but the recent earnings report had many hopeful signs. For example, the company is seeing renewed strength among its business clients.

Microsoft isn’t in good shape but it’s not nearly as dire as the share price suggests. If the company continues to deliver earnings like last quarter, I think the shares could break $37 before the end of the year.

Posted by Eddy Elfenbein on January 31st, 2013 at 8:03 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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