While Warren Buffett was celebrating his 80th Birthday yesterday, he said he will keep investing until he is 100. I sure hope so and agree with most of Buffett’s ideas. However it is hard to find a company that ‘fits’ Buffetts requirements. Microsoft today looks like a possible buy for Buffett.
Warren Buffett’s investing theory is largely based on Benjamin Graham’s ideas of value investing with the additional idea of intrinsic value. Buffett style Value investors look for securities with prices that are unjustifiably low based on their intrinsic worth. Value investors seek companies that are beneficial and of high quality but underpriced.
Buffett seeks not capital gain but ownership in quality companies extremely capable of generating earnings. When Buffett invests in a company, he isn’t concerned with whether the market will eventually recognize its worth; he is concerned with how well that company can make money as a business and the ‘franchise value’ of the business.
Here are a few things that Buffett looks for in buying ‘low priced’ and ‘high value’ companies along with an application to Microsoft (MSFT).
1. Performance over time – view the ROE from the past five to 10 years to get a good idea of historical performance.
2. The Debt to Equity Ratio – find companies with small amount of debt so that earnings growth is being generated from shareholders’ equity as opposed to borrowed money.
3. High Profit Margins – a good profit margin with consistently increasing profit margins.
4. Length of Time Public – only companies that have been around for at least 10 years
5. Unique Product – companies whose products are distinguishable from competitors
6. 25% discount to its real value – an estimated number including value of earnings, revenues, assets and franchise.
How does MSFT stock fit Buffett’s model? Here is a breakdown point by point:
1. Performance over time – In 2001 MSFT ROE was 17% by 2010 that return was 43.8% Microsoft has a very good long term ROE trend.
2. Debt to Equity Ratio – MSFTs Debt to Equity Ratio is .13 very small amount of debt.
3. Profit Margin – Based on its gross margin of 80.16%, operating margin of 38.51%, and net margin if 30.02%, MSFT converts a larger percentage of its revenues to profits than most other companies in the Software & Programming industry.
4. Length of Time Public – Well over 10 year requirement.
5. Unique Product – MSFT products are copied with little success other than Apple computer. All of MSFT products are uniquely Microsoft. Over time, many competitors have failed to effectively compete with Microsoft. With the expecption being AAPL.
6. 25% Discount – The stock is trading at a substantial discount to its value. Over the past 10 years, MSFT has consistently been highly profitable yet the stock is traing at 20% less than ten years ago today.
It’s no secret that Buffett and Gates are friends as you can see from this video:
I am sure that Mr. Buffett considers the value of a company more that the value of friendship when invesing, since he has never mentioned friendship as a basis of investing before. However, based on the six criteria outlined above, MSFT should represent an excellent buy. I look for Warren to buy into this value stock.