To efficiently gather investment ideas I track the holdings of successful investors. Lately one name is coming up again and again: Microsoft (MSFT). The funds I track, in addition to being successful, need to adhere to two criteria:
- Invest for the long term: short term traders are much harder to follow
- Match my investment style: in practice this means that fundamental valuation needs to be part of their process.
I'll briefly describe the strategy of three funds investing in Microsoft and offer an educated guess as to why. Microsoft also popped up in the holdings of other funds I track but these didn't add to their positions recently or only a few shares.
1. ValueAct Capital/Activist
ValueAct Capital acquires concentrated ownership stakes in companies that are undervalued. In this case Jeffrey Ubben, manager of ValueAct, invested 20% of his portfolio into Microsoft. That's what I call making concentrated bets. The firm tries to seek out companies that are temporarily mispriced. ValueAct is especially keen on fundamentally "good" businesses that are available at depressed valuations.
After taking a large position ValueAct tries to work constructively with management and/or the company's board to implement strategies that maximize returns for all shareholders.
In response to ValueAct acquiring a $2 billion stake in the company, Microsoft said that it will hold regular meetings with ValueAct Capital's President, Mason Morfit. In addition, Microsoft gave ValueAct the option of having Morfit become a Director beginning the first quarterly board meeting of 2014.
ValueAct wants a return of more money, according to Bloomberg. Microsoft has $77 billion in cash and investments.
According to the same article ValueAct also favors having Microsoft focus more on business software and Internet-based cloud services, putting less emphasis on consumer products.
ValueAct is extremely confident it can extract value in this name, or it wouldn't have put 20% of its portfolio into Microsoft. I suspect ValueAct invests in Microsoft to:
- Return "dead" cash to shareholders
- Focus Microsoft on business software and cloud services
2. Dodge & Cox Stocks
Dodge & Cox Stocks (DODGX) is a typical value investing fund that often takes positions that are unloved by the market. The fund invests in large-cap stocks that are on sale. To determine intrinsic value management relies on bottom-up, fundamental research and favors investing in business with good management, competitive advantages, and good growth potential.
When businesses with these qualities can be acquired on the cheap, they are usually in some kind of trouble. In case of Microsoft, it's probably not management that attracted Dodge & Cox Stocks. The firm still has no CEO to replace Ballmer. The fund is overweight technology. Holdings including: Hewlett-Packard (HPQ), Symantec Corp (SYMC) and Nokia Corp (NOK) among others. Turnover rate is generally very low at Dodge & Cox, which makes it easier to follow. Dodge & Cox Stocks probably invests in Microsoft because:
- Microsoft is cheap on a range of valuation metrics
- Microsoft has a strong competitive advantage
- Dodge & Cox sees growth potential in parts of Microsoft business. Perhaps cloud services or Windows Mobile
3. Legg Mason Value Trust
Legg Mason Value Trust (LMVTX) is the famous Legg Mason fund that was previously managed by Bill Miller, but is now under control of Sam Peters. Miller moved on to the Legg Mason Capital Management Opportunity Fund after recent underperformance. Microsoft is the 3rd largest position of the fund. The position was increased as recent as last quarter.
Peters is a value-aware manager. He seeks out firms that are careful with capital and are likely to return above average RoC going forward. I don't believe this manager is entirely bottom-up and it's possible some weight is given to stocks based on portfolio considerations. For example, Microsoft could serve as a stable cornerstone of the portfolio and serve as a stabilizer to dampen volatility. Having to guess, I think Legg Mason Value Trust invests in Microsoft since:
- Microsoft is undervalued
- Microsoft is a low-risk name that might offer great returns but also mitigates volatility
To help you see why these top managers are interested in Microsoft, I've included a spreadsheet with a few essential numbers. Valuation metrics that are especially interesting are in bold.
|Valuation Measures||Microsoft Corp|
|Market Cap (intraday)5:||300.86B|
|Enterprise Value (Jan 12, 2014)3:||237.45B|
|Trailing P/E (ttm, intraday):||13.49|
|Forward P/E (fye Jun 30, 2015)1:||12.38|
|PEG Ratio (5 yr expected)1:||1.88|
|Enterprise Value/Revenue 3:||2.95|
|Enterprise Value/EBITDA 6:||7.57|
|Fiscal Year Ends:||Jun 30|
|Profit Margin :||28.17%|
|Operating Margin :||34.58%|
|Return on Assets :||13.15%|
|Return on Equity :||30.09%|
|Revenue Per Share :||9.61|
|Gross Profit :||57.60B|
|Net Income Avl to Common :||22.64B|
|Diluted EPS :||2.67|
|Qtrly Earnings Growth (yoy):||17.40%|
|Total Cash (mrq):||79.93B|
|Total Cash Per Share (mrq):||9.57|
|Total Debt (mrq):||16.52B|
|Total Debt/Equity (mrq):||20.24|
|Current Ratio (mrq):||2.87|
|Book Value Per Share (mrq):||9.78|
|Operating Cash Flow :||28.55B|
|Levered Free Cash Flow :||18.88B|
Dodge & Cox has a knack for identifying companies with competitive advantages. ValueAct is taking an activist role to unlock value. Legg Mason might be looking for safety with an option to the upside. I can see myself following the lead of value investors with a proven track record, who appear to be highly confident, into Microsoft.