Microsoft Important Lessons in Valuation: Part 1


Before I get too deep into this article, I want to start out by stating that Microsoft (MSFT) has long been one of my favorite companies. Many years ago, I invested in Microsoft as a pure growth stock and sold it in 2000 when it became dangerous overvalued after making a very healthy long-term profit. However, I did stay out of Microsoft until October 2011 when I then invested in it as a high-quality dividend growth stock.

Thereafter, I held the stock until January 30, 2017 where I once again sold it based on what I considered dangerous overvaluation. Admittedly, I did leave a lot of capital gain on the table since 2017. However, I averaged over 20% a year – including dividends – and achieved those results at what I perceived to be very low risk. Frankly, I never regret, nor do I apologize for earning a 20% annualized rate of return over a five-year period.

This is the fourth article that I have presented on Microsoft. My first article was written on September 26, 2010 and it was titled “After A Lost Decade, Is Microsoft A Buy?” The comments I received on that article were quite negative regarding Microsoft, and consequently not real flattering to yours truly.

However, this was an interesting time because Microsoft grew earnings from fiscal year June 2000 to fiscal year end June 2010 at a rate exceeding 11% per annum. Microsoft also initiated a dividend in 2003 and grew that dividend at an average growth rate of 36% from 2003 through 2011. This was rather remarkable operating performance. Nevertheless, in 2010 investors were sour on the company because Microsoft had only generated a total annualized rate of return of 1.4% over that timeframe which was referred to as the lost decade.

Of course, the logical question would be how investment results could be so lousy, while operating performance and dividend growth were so spectacular. As a regular reader of my work, if you had not already guessed, the answer is simple and straightforward. In 2000 and 2001 the market was valuing Microsoft shares at dangerous overvaluation levels. Consequently, even though the company did well, great even, investors fared rather poorly. Clearly, valuation matters, and it matters a lot. Later in the following analyze out loud video I will clearly illustrate and elaborate on this.