Stocks to buy

Microsoft (NASDAQ:MSFT) has done quite well over the last year. This is despite the fact that in the last three to six months the stock has not done that well. Nevertheless, I still believe that MSFT stock is worth 36.5% more at $300 per share based on its powerful free cash flow (FCF).

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Consider that in the past year MSFT stock is up 37%, but just 3.2% in the last 6 months. As of Jan. 8, it was at $219.62 per share.

But this is just $9.04 higher than its $210.58 price on Oct. 8. That means it is up just 4.3% in the past 3 months. However, MSFT stock is down 1.3% year-to-date. That’s no fun.

Expected Earnings and FCF

Microsoft continues to grow. The earnings per share (EPS) forecast is 12% higher for the June 2021 fiscal year. Moreover, 27 analysts polled by Seeking Alpha estimate June 2022 EPS will be $7.45 per share.

This is 10.5% over the $6.74 forecast for the June 2021 forecast year. There are slightly lower estimates at Yahoo Finance for $7.47 in June 2022 compared to $6.76 in June 2021.

But the point is the company is set to grow, even though it has a huge $1.66 trillion market capitalization.

More importantly, the company has had an amazing FCF generation. FCF is the amount of cash flow from operations less all capital expenditure spending.

For example, its FCF in Q3 alone was an amazing $14.4 billion. This represents 38.8% of its $37.15 billion in revenue for the quarter. This is a very high FCF margin.

Therefore at this rate, Microsoft could produce $68 billion in FCF in its June 2022 fiscal year. Forecast sales for that year are $175 billion. As a result, FCF will represent 4% of its $1.66 trillion market cap (i.e., $68 billion FCF divided by $1,660 billion market cap).

What Microsoft Is Worth

This is important since the 4% FCF yield (i.e., FCF divided by market cap) is higher than the normal 3% FCF yield of its peers.

We can estimate its value if we divide FCF by 3.0%. Taking $68 billion and dividing it by 3% results in a target market cap of $2.266 trillion. This is 36.5% higher than its present market cap of $1.66 trillion.

Therefore, MSFT stock is worth 36.5% more than its price of $219.62 (as of Jan. 8). That puts its target price at $299.79, or roughly $300 per share.

And there really is no good reason why MSFT stock shouldn’t rise to that level. Its high 39% FCF margin shows that the company is extremely profitable. Almost 40% of every sales dollar gain goes straight to the cash balance. FCF can also pay for dividends and/or share buybacks.

Moreover, in the past year ending Sept. 30, Microsoft produced an amazing $49.2 billion in FCF. This is the most FCF it has ever made in a 12-month period. This occurred despite the effects of the novel coronavirus on its business.

This $49 billion in FCF represented 4.63% of its $1.06 trillion market cap as of a year earlier. In other words, MSFT stock rose during the last year or so and lowered its FCF yield. I expect it will continue to do the same over the coming year as the market realizes how powerful, steady and high margin its FCF generation really is.

What to Do With MSFT Stock

Just because we set a price target of $300 for MSFT stock, or 37% above recent prices, based on its FCF yield, does not mean it will reach that target.

However, keep in mind the stock rose 37% this past year – the same amount I am projecting its target price is above Jan. 8. And this was with the Covid-19 circumstances with sales and free cash flow below where they would have been otherwise.

Therefore, I believe there is a very high likelihood Microsoft could rise 37% over the next year.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here