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Microsoft: Price Matters

Jun. 04, 2020 4:07 PM ETMicrosoft Corporation (MSFT)73 Comments
Oleh Kombaiev profile picture
Oleh Kombaiev


  • Microsoft's WACC is currently about 7% due to a decrease in bond yields.
  • However, the DCF valuation does not point to the current undervaluation of the company.
  • MSFT becomes even more overvalued even if its price does not change.

The strongest argument that justifies Microsoft's (NASDAQ:MSFT) current price is a decrease in bond yields observed this year. This means a reduction in the discount rate and an increase in the present value of the company's future cash flow. Well, this statement is not difficult to verify by building a DCF model.

Unlike other tech giants, Microsoft's revenue sources are highly differentiated by industry. So, building a separate forecast for each segment is an almost impossible task:

In such circumstances, to forecast MSFT's revenue for the next decade, I used a polynomial model that most closely matches the current average estimates of analysts. I believe that such approach is the least subjective.

Source: Seeking Alpha

Thus, I assume that the CAGR of Microsoft's revenue in the next 10 years will amount to 11.4%. I repeat again, my forecast is based on analysts' estimates, and not on my subjective point of view. And by the way, judging from the history, this forecast cannot be called pessimistic.

Here is the calculation of the weighted average cost of capital (WACC):

Some explanations:

  • In order to calculate the market rate of return, I used values of equity risk premium (6.01%) and the current yield of UST10 as a risk-free rate (0.78%). The final indicator amounted to 6.79%.
  • I used the current value of the three-year beta coefficient.
  • To calculate the Cost of Debt, I used the interest expense for 2018 and 2019 divided by the debt value for the same years.

When building the model, I used the following key assumptions:

  • Operating margin for Microsoft for the next 10 years will gradually decline from 34% to 31% in a terminal year. In my opinion, this is an optimistic scenario for the IT industry where competition tends to increase.
  • The relative size of CAPEX

This article was written by

Oleh Kombaiev profile picture
Individual investor, data and financial analyst. I am interested in investment decisions based on objective methods of modeling and statistical analysis. Besides, I pay much attention to the psychological aspects of decision making.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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