Modern Graham Quarterly Valuation Of Microsoft Corporation

MSFT is suitable for both the Defensive Investor and the Enterprising Investor following the ModernGraham approach.

According to the ModernGraham valuation model, the company is overvalued at the present time.

The market is implying a 5.57% earnings growth over the next 7-10 years, but in recent years, the company's earnings growth has not been that strong.

Microsoft Corporation (NASDAQ:MSFT) may attract some potential investors, as the company is so well known for its products. Benjamin Graham, the father of value investing, taught that the most important aspect to consider is whether a company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment's merits. Here is a look at how the company fares in the ModernGraham valuation model.

The model is inspired by the teachings of Benjamin Graham, and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor, who is willing to spend a greater amount of time conducting further research.

In addition, Graham strongly suggested that investors avoid speculation, in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another. By using the ModernGraham method, one can review a company's historical accomplishments and determine an intrinsic value that can be compared across industries.

Defensive Investor - Must pass at least 6 of the following 7 tests: Score = 6/7

1.Adequate Size of Enterprise - Market capitalization of at least $2 billion - PASS

2.Sufficiently Strong Financial Condition - Current ratio greater than 2 - PASS

3.Earnings Stability - Positive earnings per share for at least 10 straight years - PASS

4.Dividend Record - Has paid a dividend for at least 10 straight years - PASS

5.Earnings Growth - Earnings per share has increased by at least 1/3rd over the last 10 years, using 3-year averages at the beginning and end of the period - PASS

6.Moderate PEmg (price over normalized earnings) Ratio - PEmg is less than 20 - PASS

7.Moderate Price-to-Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - FAIL

Enterprising Investor - Must pass at least 4 of the following 5 tests or be suitable for a Defensive Investor: Score = 5/5

1.Sufficiently Strong Financial Condition, Part 1 - Current ratio greater than 1.5 - PASS

2.Sufficiently Strong Financial Condition, Part 2 - Debt-to-Net Current Assets ratio less than 1.1 - PASS

3.Earnings Stability - Positive earnings per share for at least 5 years - PASS

4.Dividend Record - Currently pays a dividend - PASS

5.Earnings Growth - EPSmg greater than that 5 years ago - PASS

Conclusion

Microsoft Corporation passes the initial requirements of both the Defensive Investor and the Enterprising Investor. The Defensive Investor's only initial concern is the high PB ratio, and the Enterprising Investor has no initial concerns. As a result, all value investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company's intrinsic value.

When it comes to that valuation, it is critical to consider the company's earnings history. In this case, Microsoft has seen its EPSmg (normalized earnings) rise from $2.12 in 2011 to only an estimated $2.46 for 2015. This is not a very high level of earnings growth, and does not support the market's implied estimate for 5.57% annual growth over the next 7-10 years. The ModernGraham valuation model returns an estimate of intrinsic value falling below the current price, indicating that Microsoft is overvalued at the present time.

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