Wednesday, June 9, 2010

The stock market thinks Microsoft has just under 4 years left

(I posted this basic analysis at http://news.ycombinator.com/item?id=1417156, which was a discussion of this Newsweek article, and then decided that it was interesting enough to call out for additional attention.)

Those of us who pay attention to finance know that the market tends to be more accurate than any individual person. So sometimes it is worth analyzing what the market is saying about different companies.

If you look at the stock market, it clearly saying that Microsoft's future doesn't look as bright as Google's or Apple's. That's why Microsoft is worth a P/E of about 13, while Google is worth one of 22 and Apple is worth one of 21.

The market projection gets substantially more stark when you subtract current book value to find how much the market values future revenue. (Book value is what all of the company assets would be worth if it was broken up and sold today. For Microsoft this is largely made up of their cash reserve.) Microsoft's market cap is 221 B, their book value is 46 B, and therefore 175 B of their market cap is projected future earnings. Their current profit is 46.28 B/year, and that works out to the market valuing them at their current earnings stream projected over a bit under 4 years.

For Google the equivalent exercise says a market cap of 154 B, and book value of 38 B so 116 B of market cap is projected future earnings. Their current profit is 14.81 B/year, which translates into the market valuing them at their current earnings stream projected over a bit over a decade. (10.4 years.)

For Apple the equivalent exercise says a market cap of 225 B, a book value of 39.4 B for 185.6 B of market cap due to projected future earnings. Their current profit is 17.22 B/year, which translates into their current earnings stream projected over a decade. (10.8 years.)

So the projection that Microsoft is walking over a cliff in a few years while both Google and Apple have a decent future. The market is perfectly aware that a lot changes in 10 years, and so they heavily discount any projections out that far. But the market is more likely to be correct for near events.

Now admittedly I've never liked Microsoft. But this isn't just claimed by some random haters on the Internet. This is the consensus of the stock market, which is based on a lot of informed people putting their money where their mouths are. This is worth thinking about.

(I took all figures for this from http://finance.yahoo.com/q/ks?s=msft, http://finance.yahoo.com/q/ks?s=goog and http://finance.yahoo.com/q/ks?s=aapl. I got book value by multiplying book value / share times shares outstanding.)

8 comments:

David J. Sokol said...

Doesn't this completely ignore the valuation of risk? Microsoft's business is stable, whereas AAPL and GOOG are constantly moving and unknown. They are projected to _increase_ their profits, and the valuation is coming from the their book value, future potential profits, and the risk of not actually knowing. Microsoft has been serving their core business for quite some time and they aren't going to be shaking things up as much as google or apple.

And the market is usually right, unless technology is involved. (See also: dot com bust)

Johnny Dough said...

Are your sure the numbers add up for GOOG? I got it to 8 years.

David said...

You're confusing gross profit with net income. Gross profit doesn't take into account things like R&D costs. It simply calculates how much stuff cost to make and the price at which that stuff sold. You don't just add gross profit to market cap at the end of the year. There are other costs involved.

The stock market doesn't believe that MSFT is falling off a cliff in 4 years. It believes that MSFT is an established business that is unlikely to grow at the same rate as AAPL or GOOG over the next few years.

A P/E of 13 is fairly normal for an established company. It is comparable to companies like AT&T or Berkshire Hathaway. Nobody thinks AT&T is disappearing in 4 years. At the same time, internet search and online music sales are much higher growth industries over the next few years than desktop operating systems and office productivity suites.

DM said...

Your description of book value is wrong:

- Book value is what all of the company assets would be worth if it was broken up and sold today

That would be the market value of the company's assets. The book value is the value reflected on the balance sheet.

The difference between book value and market capitalization cannot be simply explained by 'projection of future earnings'. It depends on many components such as business risks, financial risks, company's cost of capital, goodwill etc.

Jason said...

There are all sorts of problems here, but the one most worth pointing out is in reference to Mr. Sokol's comment. The market does not reward extra risk with extra valuation. Rather, it is exactly the opposite of that. Classical valuation theory has plenty of wholes in it, but for the most part investors really do demand compensation for assuming additional risk. Demand for compensation = lower current valuation = higher potential return.

Investors do pay for growth potential, and companies with the potential for high growth do tend to be the same companies that are taking risks in their markets, but the risk does not cause the valuation. If a company somehow manages a low-risk strategy for high growth, they are likely to receive a higher valuation than a company with a high-risk method of growth.

As a side note, I suggest that Microsoft's entire business model is anything but stable at the moment.

Maintenance Man said...

Why do the all the ads on your blog seem to be Public Service Announcements? Did you choose this somehow in AdSense? Or are Google employees only allowed to have PSAs? It just seems very strange to me. Nice writing on your blog by the way.

JohnMathew said...

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David Amos said...

Microsoft, what should we expect and predict. How will MSFT perform in the upcoming time.