Microsoft (NASDAQ:MSFT) could reach $400 per share and have a $3 trillion market capitalization. This forecast for MSFT stock to rise over 41% is based on its huge free cash flow (FCF) and high FCF margins. Investors will get a better sense of this when Microsoft releases on July 27 its fiscal Q4 earnings ending June 30.
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Keep in mind that Microsoft has moved up 26% year-to-date as of July 15 when it was at $281.06 per share. In addition, since the end of March, it is up 19%. This is likely due to the huge FCF generation that the company made in its fiscal Q3 ending March.
In my last article on Microsoft on May 27, I argued that MSFT stock was worth 52% more at $383 per share. That was when the stock was at $251.07. I used a run-rate FCF method to value Microsoft. Since then, it has risen 11.9% to $281.06. I use a slightly different method to value the stock now, giving it a $400 target price, up 41.5%.
Estimating Microsoft’s Future FCF
In its fiscal Q3, revenue jumped 19% year-over-year (YoY) and operating income rose 31% to $17 billion. Its non-GAAP (generally accepted accounting principles) earnings per share (EPS) rose 39% to $1.95.
In addition, Microsoft’s FCF rose 24% in the past year to $17.09 billion. This represents a huge 41% of its quarterly $41.7 billion in revenue for the March quarter. We can use that 41.4% margin figure to estimate its future FCF.
Most companies are lucky if they can get a 20% FCF margin. About 41% of every Microsoft sales dollar ends up as pure cash profit. This is after all capital expenditures, changes in working capital, SG&A, taxes and cash payments have been taken out. It means 41% of those sales dollars are “free” for stock buybacks, debt payments, dividends, acquisitions or simply to store on its balance sheet.
We can use this to estimate Microsoft’s FCF going forward. For example, analysts culled by Seeking Alpha forecast that sales for the year to June 2022 will reach $185.71 billion. Using its 41% FCF margin we can estimate FCF will hit $76.1 billion by June 2022.
Source: Mark R. Hake, CFA
As the table on the right shows, this implies that by June 2022 FCF will be 41% of its $185.7 billion in estimated sales. That also represents 11% growth over 2021 and 68% over the 2020 FCF figure.
Using FCF Yield to Value Microsoft
Given that this FCF margin is so high, the market puts a high valuation on MSFT stock. If we divide its annual trailing 12 months (TTM) FCF by the market cap we can derive its FCF yield.
For example, using in the trailing months (TTM) to Mar. 31, Microsoft made $53.08 billion in FCF. This can be seen on the page that Seeking Alpha provides for TTM cash flow from operations (CFFO) of $72.703 billion. Next, we subtract $18.914 billion in capex spending, the TTM FCF was $53.08 billion.
So, if we divide this $53.08 billion by Microsoft’s market cap of $2.12 trillion, the FCF yield is 2.54%.
Source: Mark R. Hake, CFA
So, if we apply the 2.54% FCF yield to the 2022 forecast of $76.1 billion for June 2022, the expected target market cap is $2.996 trillion ($76.1 billion / $2.996 trillion). This is very close to $3 trillion. This is 41.3% over today’s market capitalization of $2.12 trillion. This also implies that MSFT stock is worth $397.10, which is close to $400 (less than 1% higher).
Where This Leaves MSFT Stock
When Microsoft releases its Q2 earnings and the related cash flow statement we will be able to revise this calculation. Based on how high its FCF margin goes we may be able to increase the target to over $3 trillion.
Keep in mind that we are using its historical FCF yield from the TTM ending March 31. Once we receive the new quarterly results, we can reset the FCF yield number. Keep in mind that the higher the FCF dollar figure, the higher the FCF yield metric will be. That means the target price for MSFT stock will be lower.
Nevertheless, MSFT stock should reach $3 trillion in market value in the next year if its FCF continues to power ahead. Look for MSFT to hit $400 or 41.5% over today’s price.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.
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