In this article, we will take a look at the DCF analysis of Microsoft Corp. (MSFT, Financial), a reliable and data-driven approach to estimating the intrinsic value of the company. Instead of using future free cash flow as in the traditional DCF model, GuruFocus’ DCF calculator uses EPS excluding NRI as the standard for the DCF model, based on research that shows that stock prices have historically been more highly correlated with earnings than free cash flow.
As of July 8, 2024, the intrinsic value of Microsoft Corp., calculated using the discounted earnings model, is USD 305.52. The company is currently trading at a price of USD 467.56. Therefore, the margin of safety according to the DCF model is -53.04%. The company is slightly overvalued.
The model
The GuruFocus DCF calculator follows a two-stage model by default. This model consists of the growth stage and the terminal stage. In the growth stage, the company grows faster, while in the terminal stage, a lower growth rate is applied because sustained fast growth is not sustainable in the long run. The intrinsic value of Microsoft Corp. estimated using the discounted earnings model is determined by the following assumptions and steps.
Assumptions
| Expression | Value | Explanation |
|---|---|---|
| EPS without NRI | $11.56 | GuruFocus’ DCF calculator defaults to EPS excluding NRI because stock prices have historically been more correlated with earnings than with free cash flow. |
| Discount rate | 11% | A reasonable discount rate is usually the risk-free rate plus the equity market risk premium. GuruFocus uses the current 10-year Treasury constant maturity rate of 4.31%, rounded up to the nearest whole number, which is 5%. Then a risk premium of 6% is added to arrive at the estimated discount rate. |
| Growth phase | Growth rate (g1) = 17.50% Years of growth phase = 10 |
We choose the growth rate based on availability, giving preference to the average EPS excluding NRI growth rate of the last 10, 5 or 3 years in that order and then set a cap between 5% and 20% to maintain a fair and balanced estimate. The default growth period is set to 10 years. |
| End stage | Growth rate (g2) = 4% Years in terminal stage = 10 |
In the final phase, earnings per share will grow at 4% for 10 years. It is important to ensure that the terminal growth rate remains lower than the discount rate to facilitate convergence in the calculation. |
calculation
| Growth phase | = | EPS without NRI | * | ( (1 + g1) / (1 + d) | * | (1 + g1)^2 / (1 + d)^2 | + | … | + | (1 + g1) ^ 10 / (1 + d) ^ 10 ) | ||
| = | 160.25 | |||||||||||
| End stage | = | EPS without NRI | * | (1 + g1) ^ 10 / (1 + d) ^ 10 | * | ( (1 + g2) / (1 + d) | + | (1 + g2)^2 / (1 + d)^2 | + | … | + | (1 + g2) ^ 10 / (1 + d) ^ 10 ) |
| = | 145.28 | |||||||||||
| Intrinsic value: DCF (earnings-based) | = | Growth phase | + | End stage | = | 305.52 | ||||||
Discounted free cash flow model
GuruFocus also offers the calculation using the traditional free cash flow approach. Using trailing twelve months (ttm) free cash flow per share as a parameter, the DCF eigenvalue based on free cash flow is $183.55. This valuation shows that Microsoft Corp. is significantly overvalued, accompanied by a margin of safety of -154.73%. You can always switch to using free cash flow per share to calculate the real DCF model on our DCF calculator page.
The conclusion
Please note that while the DCF model is a robust valuation method, it is based on various assumptions and projections that may affect the accuracy of the final intrinsic value calculation.
Here are some considerations for using the DCF model:
- Future earning potential: The DCF model values a company based on its potential future earnings.
- Welcoming growth: Growth plays a crucial role. All else being equal, a company with rapid growth has a higher value.
- Predictability: The model assumes that a company will grow at the same rate as it has over the past 10 years, so it is more suitable for companies with consistent performance. For companies with unpredictable performance, such as cyclical companies, the DCF model may be less accurate and a larger margin of safety should be considered.
- Discount rate: Choosing an appropriate discount rate is of utmost importance. Using your expected return on investment is a sensible choice for the discount rate.
Navigate with GuruFocus:
With the GuruFocus All-in-One Screener, you can easily search for stocks that are currently trading below their Intrinsic Value: DCF (FCF-based) and Intrinsic Value: DCF (Earnings-based). To identify undervalued, predictable companies, focus on those with a high Predictability rank that are trading at a discount to their Intrinsic Value: DCF (FCF-based) and Intrinsic Value: DCF (Earnings-based).
This article created by GuruFocus is intended to provide general insights and does not constitute tailored financial advice. Our commentary is based on historical data and analyst forecasts, uses an unbiased methodology and is not intended to serve as specific investment advice. It does not contain a recommendation to buy or sell any stock and does not take into account any individual investment objectives or financial circumstances. Our goal is to provide long-term, fundamental, data-driven analysis. Note that our analysis may not include the most recent, price-sensitive company announcements or qualitative information. GuruFocus does not hold a position in any stocks mentioned here.
