Peter Mycroft Psaras'  Instablog

The following is a Free Cash Flow Analysis of the company from 1993-2011. The key ratios that I will use in the analysis are price to free cash flow (PFCF) and Free Cash Flow Return on Invested Capital (FROIC) as well as debt to equity.

When investing I look for PFCF below 15 times and FROIC above 20%+. When you are lucky enough to find a combination of the two you find a perfect balance of growth + value and you get capital appreciation through capital preservation.

For those who don't know;

PFCF =Market Price/ (Cash flow per share-Capital Spending per share)

FROIC = FCF per share/ (long term debt per share + shareholders equity per share)

FROIC basically tells you how much return in free cash flow a company generate for every dollar of Total Capital they employ.

I consider FROIC the primary determining factor in identifying growth companies as you can compare every company (except financials) on an equal basis. The question I ask every company I analyze is = how much return (in percent) in FCF are you going to give me for every dollar of total capital you invest?

First here are the numbers;

As you can see from the table above that Microsoft has always done an amazing job on Main Street, but the reason that the stock did not do much from 1998 to today is because it was very overvalued in 1998 and took some ten years to get back to being attractively priced.  The company’s FROIC suffered tremendously from 2000-2004 because they were making just too much cash and didn’t have anywhere to park it. Eventually they made the smart move and paid out about $30+ billion in a one time dividend to shareholders and their FROIC then went back to its high growth range.

Management has made some mistakes in the last couple of years, such as running certain divisions at a loss, to retain market share and trying to buy Yahoo(YHOO) outright.   
They then made the mistake with Vista , which I still use and still have problems with.  I am planning to upgrade to Windows 7 soon as I have read nothing but rave reviews from IT pros on how well it works.

As for the statistics on Windows 7 , there are close to 1 billion computers worldwide using  the Windows operating system.  On top of that there will be over 300 million new computers sold this year with the Windows 7 operating system pre-installed.  Apple (AAPL) for example will sell 10 million with its operating system loaded on them (a 30 to 1 difference).   As for global operating system market share Microsoft has a 91.61% share while Apple has a 4.59% share and Linux at 0.95%.

http://en.wikipedia.org/wiki/Usage_share_of_desktop_operating_systems

  In Conclusion when you can get a company that is so dominant globally and is selling at close to its record  low Price to Free Cash Flow and record high FROIC historical numbers, I would look into it as a potential stock for one’s portfolio.

To assist you I would also link to Seeking Alpha's transcript of Microsoft's latest earnings conference call (thank you Seeking Alpha for providing it free)

seekingalpha.com/article/168520-microsof...

 FROIC gives me a company's real return on Main Street and if I can get a 20%+ return on Main Street and at the same time buy a stock that is selling for less than 15 times its FCF then there is a very high probability that it should be very successful investment.

By choosing 20%+ as my minimum FROIC I have built a portfolio of 29 holdings for my clients that has a combined portfolio FROIC of 32% and sells as a group for 12.35 PFCF.

As for PFCF I came up with the 15 or less number as being Ideal after performing a 58 year backtest. To view the backtest just click the link below.

mycroftresearch.com/uploads/Backtest_195...


Disclosure Long MSFT  No Position AAPL, YHOO

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