With the price of Apple stock having increased from $78 per share to almost $128 per share in the last year (for a gain of 64% in share price along, plus you would have to include the four dividends), it is easy to understand why Microsoft has gotten much less attention. In fact, it is almost impossible to discuss Microsoft stock in its own right without the relatively superior performance of Apple coming up in conversation. I’m not going to do that today because everyone knows Apple’s growth has been superior. Instead, I’ll tell you what I see when I study Microsoft: a company that mints cash.
Even as the company tries to spend its cash by acquiring things like Nokia phones and X-Box, and pay out $10.1 billion in annual dividends to shareholders each year, the cash hoard continues to grow. Microsoft had $77 billion in cash in 2013, $85 billion in cash last year, and $90 billion in cash now. Its cash position is one fourth the size of its market capitalization: In other words, it is a $43 dollar per share stock that has the current cash hoard to pay out nearly $11 per share in dividends. This is a fiction I set up because Microsoft wouldn’t actually want to have no cash on hand nor would it be advisable under current tax law to repatriate the overseas cash and pay a tax on it (it would take another repatriation holiday from Congress for Microsoft to properly possess $90 billion on an after-tax basis).
But still, focusing on cash possessed by a business is something that investors don’t do nearly enough—they look at five year profit growth or ten year profit growth, and put excessive faith in those metrics. There is a substantial difference between a company that regularly leverages the balance sheet, borrowing cash at 3%, 4%, or 5% long-term interest to repurchase its own stock at market highs compared to companies that have clean balance sheets and report lower growth numbers.
Why does that matter? Because high cash balances represent dynamic, untapped power than can rapidly increase the earnings base of a company. You buy a profitable business for 10+ billion, suddenly your profit base increases overnight and everyone’s estimates of fair value for the stock go up. Whether it be balance sheet illiteracy regarding cash hoards or the uncertainty they represent (you don’t actually know ahead of time what business a company might be so some of your analysis is necessarily a big unknown), there is usually little mention of how unusually high amounts of cash affect the calculation of what is a fair price to pay for the company.
For instance, some people look at Berkshire Hathaway and see a stock that has gone from a high of $90 in 2012 to $119 in 2013 to $150 in 2014, and think the stock has gotten a little ahead of itself, or at a minimum, is fairly valued. I think the stock is still undervalued: Most people don’t fully appreciate the scope of the $28 billion bond portfolio which pays low interest right now (though there are a few super sweet privately negotiated deals in there, too), the $116 billion stock portfolio in which people tend to focus on the income from the generally low dividend payers without thinking about the retained earnings of those investments and the future growth that is propelled as a result, and lastly, the $62.3 billion sitting there in cash.
When a man who has compounded his wealth at over 20% annually over the course of the past five decades is sitting on $62 billion, something big and lucrative is bound to happen between now and the next few years. Use the Heinz acquisition of two years ago as example. Back in 2011, Berkshire Hathaway was making $2.11 per B share in profit. The book value was $68 per share. Fast forward to 2013, after the Heinz acquisition, and the terms changed drastically. Berkshire added Heinz, and the rest of the operating companies performed well. Blended together, Berkshire was making $3.30 per share in profits by 2013, and the book value increased to $91 per share. Within two years, the profits went from $2.11 to $3.30 and the book value went from $68 to $91 because the untapped energy of a high cash balance got converted into earnings power by the acquisition of a business.
This is why I find Microsoft’s $22 billion per year in profits and slightly over $90 billion in cash assets compelling. In 2003 and 2004, Microsoft stock was trading in the $20s and decided to pay out a one-time special dividend of $3 per share to its owners. If you purchased the stock in the year before the announcement, you got a one-time payment of 12% of your invested capital. If you chose to reinvest it into additional shares of Microsoft, you got to immediately turn every 100 shares of Microsoft into 112 shares of Microsoft going forward that would pay out dividends in their own right. Microsoft has the capacity to do something like that again, perhaps announcing a special dividend in the $6 per share range if it wanted to still keep tens of billions of dollars in cash regardless.
Or it could announce a massive stock buyback or go on the acquisition hunt a la the Buffett example mentioned earlier. The point is that $90 billion in cash will *do something* at *some point*, and that is something that isn’t presently captured when you pull up a stock screener and see that Microsoft is a $43 stock trading for over 17x profits. Looking at the company’s balance sheet, there is more to the picture than immediately meets the eye.