/Microsoft%20Corporation%20logo%20on%20sign-by%20Jean-Luc%20Ichard%20via%20iStock.jpg)
Microsoft (MSFT) produced excellent fiscal Q4 quarterly results on July 30. This included 15% higher revenue on a Y/Y basis and 18% higher free cash flow (FCF). So why is MSFT stock falling?
For example, Microsoft generated 36% of its sales as FCF during the quarter ending June 30 (i.e., $23.3 billion in FCF/$64.73 billion in sales). That was higher than last quarter's 33.9% FCF margins (i.e., $20.965 billion FCF / $61.858 billion in revenue).
This was even after Microsoft spent significantly more in capex for its AI-related initiatives. Capex rose from $10.95 billion last quarter to $13.87 billion, a quarterly rise of 26.7%.
As a result, MSFT stock looks very undervalued here. It could be worth at least 21.9% more or $495 per share. This article will show why.
Higher Free Cash Flow Predicted
In the last 12 months (LTM), Microsoft produced $74 billion in free cash flow. That represented 30.2% of its LTM revenue of $245.1 billion. Therefore, its FCF margin has risen from 30% on a LTM basis to 36% in its latest quarter.
As a result, Microsoft's free cash flow could range between $84 billion and $100 billion next year. This is based on analysts' forecasts of $278.93 billion in revenue for the year ending June 30, 2025 (i.e., 30.2% x $278.93b = $84 billion, and 36% x $278.93b = $100.4b).
In other words, on average the company is on track to generate $92 billion in FCF. This is useful in setting a price target for MSFT stock.
Target Price for MSFT Stock
One way to do this is to use a FCF yield metric. For example, given that the stock has a $3.019 trillion market cap today, Microsoft's $74 billion in LTM FCF represents a yield of 2.45% on that market value (i.e., $74b/$3,019b = 0.0245).
In other words, assuming the company paid out 100% of its FCF as a dividend, the stock would have a dividend yield of 2.45%. That is significantly higher than its present 0.72 dividend yield.
Therefore, if we assume that the forecast $92 billion next year is paid out in dividends, the market cap might rise to $3.68 trillion. This can be seen by dividing $92 billion by 2.50% (i.e., $92b/0.025 = $3,680 billion).
That is 21.89% higher than its market cap today of $3.019 trillion. In other words, MSFT stock could be worth 21.9% more over the next year (i.e., 1.2189 x $406.20 today = $495.12 per share).
Analysts Agree
Analysts on Wall Street have significantly higher price targets as well. For example, Barchart's survey shows that the mean price target is $501.53 per share. Yahoo! Finance shows a $497.03 price target for 46 analysts. These both average $499.28, or 22.9% over today's price, similar to my result.
Moreover, AnaChart, a new sell-side analyst tracking service, shows that 38 analysts have an average price target of $468.76 per share. That is 15.4% higher than today's price.
The bottom line is that most analysts see the stock as undervalued, even after today's supposed earnings miss and the lower stock price.
Maybe it's better to look at free cash flow (FCF) to determine a stock's value, rather than whether a company makes its expected numbers.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
