Microsoft; MSFT, A Good Investment? April 29, 2006

Microsoft suffered from the biggest single day decline since December 2000 as its share slided more than 11% yesterday. This is equivalent of a loss of $32B in a single day! The hot issue now is whether this company is a buy or not.

Prof. B. Greenwald, from Columbia Business School, has said in his lecture before that big company like Microsoft has hundreds of analysts following it. Therefore, it is crucial to know why you think you are right in comparison to the army of analysts.

Let me do some simple analysis on Microsoft:

Step 1: FCF/EV yield vs. Treasury yield

Enterprise Value (EV) = $232B

Free Cash Flow (FCF) = $14.5B

FCF/EV yield = 6.25%

Treasury yield (30 years) = 5.17%

Microsoft looks like a better deal than treasury yield.

Step 2: Insider holdings

I have mentioned about superior return by investing in founder-CEO companies. Investing in companies that have significant insiders holding is one of the great ways to achieve superior return.

Steve Ballmer and Bill Gates have holdings over 10% of the Microsoft, and they have significant passion for this company. Without doubt, they will work extremely hard to expand Microsoft Empire.

To read my previous comment on insiders holding, please visit: http://dahhuilaudavid.blogspot.com/2006/04/superior-stock-return-by-having.html

Step 3: Is Microsoft a Good Company?

Profit Margin (ttm): 31.57%
Operating Margin (ttm): 40.92%

Return on Assets (ttm): 16.09%
Return on Equity (ttm): 28.56%

By looking at these simple indicators, Microsoft is not only a good company, but a superior one.

Step 4: Does Microsoft management shareholders-orientated?

Microsoft has been buying its own shares aggressively; purchasing up to $13.88B, which is more than its income of $13B. On top of that, Microsoft has paid up to $3.44B of dividend. I view this move as a very favorable management of Microsoft. Buying back shares and paying dividend are important steps to enrich shareholders, as long as it doesn’t restrict its financial ability to expand and improve its service.

Step 5: Do you understand its Business?

Almost everyone uses Microsoft products, and it is a simple company to understand. Microsoft Corporation engages in the development, manufacture, license, and support of software products for various computing devices worldwide. As Microsoft is famously known, I’m not going to elaborate further on its business.

Step 6: Does Microsoft have a Moat?

Warren Buffett emphasizes “moat” seriously. He would only invest in companies with “castle-like moat with alligators swimming around it”. At the moment, Microsoft does have significant moat with its dominance in PCs operating systems (over 90% of operating systems use Microsoft products). However, it is hard to tell what will happen in 10 years time. That is why Warren Buffett has not invested in a significant way in Microsoft despite Bill Gates is his good buddy.

Step 7: Does any superinvestor invest in Microsoft?

There are some superinvestors interested in Microsoft, e.g. Charles de Vaulx (2.79% of assets), George Soros (2.52% of assets), Brian Rogers (1.33% of assets) and others. However, I have not found any superinvestors invest in a significant way in Microsoft.

Step 8: What are the potential risks in buying Microsoft?

As I discussed above, I am not sure how will Microsoft’s moat evolves in 10 years time. In this fast changing world, many things could happen, and technology and software may become obsolete really fast. If Microsoft failed to maintain its superior software, its moat will evaporate.

As importantly, size matters in determining superior stock return. Microsoft has one of the largest capitalizations in the world. The bigger the company, the lower the return. However, John Chew, an independent analyst wrote……

“Intel, MSFT, Coke, CISCO are all behmouths--they became huge through their dominance, so their size will limit returns vs. a smaller cap company.

However, what you give up in returns you may pick up in safety through their consistent slower growth IF the management knows they are over capitalized and return cash to shareholders through buybacks and dividends.

MSFT is essentially a utility company--they control 95% of the operating systems market and they earn 100%+ returns on tangible capital, the problem is what do they do with the cash? Let it sit on the balance sheet, deworseify, or give it back to shareholders. If mgt. returns cash to shareholders then buying at a 30% discount to IV with IV growing through 4% to 6% organic growth and 4% to 6% share buybacks or dividend yield is not bad given that it probably will be hard for the market to average much above 6% over the next few years.”

Conclusion:

Microsoft is a buy for me at current price of $24.15. I’m going to end my discussion here by quoting Warren Buffett….

“Buy companies with strong histories of profitability and with a dominant business franchise.”

Happy investing,
Dah Hui Lau (David)
dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Investment from Difference Perceptive April 28, 2006

When people talk about investment, everyone thinks of shares, bonds, property and etc. However, there is more important investment other than making plenty of money that is HEALTH. There is a Chinese proverb that says to have good health is to have wealth. I couldn’t have agreed more.

I want to talk about cessation of smoking today as a way to be truly rich; HEALTH wise as well as MONEY wise.

If you were a smoker, stopping smoking not only improves your health tremendously, but also make you truly rich too.

Imagine that you smoke on average 10 cigarettes per day, since you were 20 years old until 50 years old. In 30 years time, you would have smoked 109,500 cigarettes! A pack of cigarettes costs about £5. Thus, you would have spent £27,375!

Even if you don’t know how to invest in shares or property, you could easily put the money in bank, i.e. INGDirect, that offers 4.5% interest. If you do just that, the amount of money that you will get when you are 50 years old is a staggering £57,000!

If you know how to invest, and could get return of 10% over 30 years, you would end up with £170,000!!! Could you believe this? Just by giving up smoking, you could potentially gain £170,000.

Not only that, you will gain significant improvement HEALTH wise. Cigarette smoking is widely recognized as the leading preventable cause of illness, disability, and premature death. Today one in five deaths is cigarette-related!

It is now well documented that regular smokers increase their risk of death by

Lung cancer 700%

Cancer of the larynx 500%

Cancer of the mouth 300%

Cancer of the esophagus 400%

Bladder cancer 100%

Cancer of the pancreas 100%

Emphysema 1,300%

Heart disease 100%

I’m going to end here. Hope you take some time to contemplate on this issue seriously. If you were a smoker, please stop smoking. Smoking WILL KILL you and make you POOR.

Happy investing and good health to you!

All the best,
Dah Hui Lau (David)
dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Stick with the simple, if scary, solution; April 21, 2006

There’s certainly no dearth of advice on investment. The bestseller lists are full of books on how to be a successful investor “in only 15 minutes a week”, on how to become an “automatic” millionaire, and about how to invest if you’re “young, fabulous and broke”.

The best book on the subject in years is value investor Joel Greenblatt’s The Little Book That Beats the Market, which is still a top seller months after its release. Beyond the credibility that comes from someone whose private investment partnership, Gotham Capital, has produced 40 per cent a year returns over the past 20 years, Greenblatt also brings an elegant and simple writing style to what can be a complicated subject.

He outlines a “magic formula”, based on how he himself invests, that anyone can use. The formula has only two inputs, a company’s earnings yield and its return on capital. The rationale is straightforward: buy shares in good businesses, measured by returns on capital, only when they’re available at bargain prices, defined as a high earnings yield.

The magic formula looks for companies that have the best combination of earnings yield and return on capital, with each input weighed equally. An outstanding company with an expensive stock ranked, say, first for return on capital but 1,999th on earnings yield, would have the same combined ranking of 2,000 as a low return on capital company with inexpensively priced shares, ranking 1,999th in return on capital but first on earnings yield.

Using this approach to create a regularly updated portfolio of about 30 stocks with the highest combined rankings, Greenblatt tested his formula between 1988 and 2004. The results were remarkable: with only one down year, the magic portfolio would have returned 30.8 per cent a year, against a 12.4 per cent annual return for the S&P 500.

Rather than using the latest 12 months’ earnings to calculate earnings yield and return on capital, Greenblatt and his analysts try to improve on the rote application of this formula by using earnings estimates in a “normal” year, one in which nothing unusual is happening within the company, its industry or the overall economy.

Greenblatt has created a free website for screening stocks based on his approach (www.magicformulainvesting. com). In a recent screen I carried out there of the top 100 magic formula companies with market capitalisations above $2bn, the top 10 companies ranked by market cap were Exxon Mobil [XOM], Microsoft [MSFT], Pfizer [PFE], Johnson & Johnson [JNJ], IBM [IBM], Intel [INTC], ConocoPhillips [COP], Dell [DELL], 3M [MMM] and Motorola [MOT]. Now that’s an impressive group of companies!

I own one of them (Microsoft) in my portfolio. Given how sceptical I am about the tech sector, owning this is a real leap for me but this is a fantastic business and the stock is attractively priced. Microsoft has a dominant franchise, some of the most jaw-dropping economic characteristics ever achieved, capable, honest, shareholder-friendly management and, unlike most technology companies, reasonably predictable future prospects.

I am optimistic about Microsoft’s future prospects for a number of reasons. Most important, the company will be releasing in the next year significant upgrades of its two cash cows, Windows and Office. Historically, these events have been big and highly profitable events for Microsoft, and there is no reason to believe otherwise this time.

Yes, Microsoft’s days of ultra-high growth are over, inevitable for a company with $40bn in annual revenues. But it is highly likely the company will grow substantially faster than the S&P 500 for many years to come and that its fabulous economic characteristics will remain largely intact.

At a recent price around $27, Microsoft, after adjusting for the company’s cash hoard, is trading at under 17 times earnings estimates for this calendar year.

I don’t claim this is screaming cheap but it is close to the lowest p/e multiple the stock has ever traded at and is, I believe, a very attractive price for a company of its quality and bright future.
You might wonder if Greenblatt is concerned that popularising his strategy will mean it will stop working. “Traditional value investing strategies have worked for years and years and everyone’s known about them,” he says. “They continue to work because it is hard for people to do, for two main reasons. First, the companies that show up on the screens can be scary and not doing so well, so people find them difficult to buy. Second, there can be one-, two- or three-year periods when a strategy such as this doesn’t work. Most people aren’t capable of sticking it out through that.”

Whitney Tilson is a money manager who co-edits Value Investor Insight and co-founded the Value Investing Congress.

This article is from: FT.com

While Whitney Tilson owns Microsoft, we owned Intel. :)

All the best,

Dah Hui Lau (David)

dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Some Great Quotes; April 26, 2006

"Each man is the architect of his own destiny." (Claudius Caecus)


"He did it with all his heart, and prospered." (II Chronicles 31:21)

All the best,
Dah Hui Lau (David)
dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Bill Miller: Where to Invest Now and the 5 Year Psychological Cycle April 26, 2006

Where should we invest now, we should invest where the returns have lagged in the past 5 years, according to Bill Miller. He wrote: The US equity market has lagged those of the rest of the world by a wide margin for several years, and within our market the mega cap S&P names have lagged the small and mid caps, which are in the 7th year of relative outperformance, quite long in the tooth by historic standards. Part of the reason for the relative lack of interest in US stocks has been the relentless rise in short rates. Our central bank has been noticeably more hawkish than the rest of world, and money has flowed to where money was the easiest, outside the US. As we end our tightening cycle, and others remain engaged in theirs, our market should become relatively more attractive.

In a world where global liquidity may be diminishing, relatively illiquid assets are likely to begin to lose their allure. Liquidity will become more valuable. I think the most liquid market in the world, the US market, will become more attractive, and within that market, money will flow to the largest, most liquid names, which also happen to be the cheapest part of our market

The excitement and enthusiasm surrounding commodities, and the belief that they will continue to rise, is not surprising. People want to buy today what they should have bought 5 or 6 years ago; call it the 5 year psychological cycle.

Today people want commodities, emerging market, non US assets, and small and midcap stocks. Those were all cheap 5 years ago and had you bought them then you would be sitting on enormous gains. But 5 or 6 years ago, everyone wanted tech and internet and telecom stocks, and venture capital and US mega caps. The time to buy them was in 1994 or 1995, when they were cheap. But in 1994 or 1995, people wanted banks and small and mid caps, which should have been bought in 1990, and well, you get the picture.

In general, you can get a good sense of what to buy now by looking to see what the worst performing assets or groups were over the past five or six years. That is long term for most people, and long enough to convince them that the malaise is permanent and to have migrated their money elsewhere, such as to whatever has done best in the past 5 or 6 years.

Given the choice of buying Commodities with a capital C, or buying capital C-Citigroup at current prices, I’ll take the latter. Check back in 5 years.

To read the complete letter

Thank you GuruFocus for the link.

All the best,
Dah Hui Lau (David)
dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Wallace Weitz; Be prepared April 21, 2006

Wally Weitz wrote in his shareholder letter: "We continue to believe that excessive credit creation and speculation in both real estate and securities markets will cause some anxious moments, at best, and possibly some serious financial distress for the stock market over the next few years. We are not cheering for trouble, but we think it is important to be prepared, just in case. So, we have continued to focus our portfolios on companies with strong balance sheets and managements that are flexible enough to deal with both favorable and hostile business environments. We offer no predictions about the next few quarters, but we feel very optimistic about the long-term prospects for the companies in our portfolios."

To read the complete letter

Thank you GuruFocus for this link.

All the best,
Dah Hui Lau (David)
dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Some great quotes April 21, 2006

I like to share with you some great quotes that I come across....

"Quantum physics tells us that things do not change slowly over time – they make quantum leaps."

"There are no shortcuts to any place worth going." (Beverley Sills)

"Storms make oaks take deeper root." (George Herbert 1593-1633)

Hope you enjoy these quotes as much as I do.

Do share your previous quotes if you have any.

Happy learning,

Dah Hui Lau (David)

dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Superior Stock Return by having "Founders Keepers" April 20, 2006

I have recently read a great article from Fortune Magazine called Founders Keepers.

Let me quote this interesting sentences from the article...

"The stocks of these 26 companies (plus Liberty Media, whose founder John C. Malone stepped down as CEO March 1, but remains chairman) returned an average of 18.5 percent annually from year-end 1995 through 2005, which is seven percentage points better than the FORTUNE 500's average return over the same period. Their profit growth has been superior, too, increasing at an average rate of 19.6 percent a year from 1995 to 2005, vs. 11.7 percent for the FORTUNE 500."

"Of course, 27 companies is a small sample, and we might have written this off as a statistical fluke had we not come across the research of an Ohio State University finance professor named Rudiger Fahlenbrach. Fahlenbrach analyzed the performance of the 2,300 largest U.S. companies from 1993 through 2002, and he discovered that those run by founder-CEOs (11 percent of the total sample) outperformed the broader stock market by eight percentage points a year."

I am very impressed by this significant findings of Rudiger Fahlenbrach.

"Fahlenbrach has a few theories on why founder-CEOs seem to be better corporate stewards. One is that they simply care more. Their companies are their life's work, so they're more likely to embrace long-term strategies. "

I totally agree with Fahlenbrach theory why founder-CEO companies perform better over long period of time.

This article also reminds me of Jim Chuong, the emerging great value investor with superconcentrated portfolio. Jim Chuong, in his partnership letters, also emphasized that he only invests in companies with significant insider holdings. Just look at his superior return, and you will agree that investing in companies with significant insiders' holdings could deliver wonderful returns.

Hope you will pay more attention to companies with founder-CEOs.

Happy investing,
Dah Hui Lau (David)
dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Russell Corporation; RML April 20, 2006

Berkshire Hathaway has recently announced that it is purchasing Russell Corporation for $600M. I believe that by learning why Warren Buffett is buying into this company, we could learn about art of investing from the master investor.

Russell Corporation, an athletic and sporting goods company, engages in the manufacture and marketing of athletic uniforms, apparel, athletic footwear, sporting goods, athletic equipment, and accessories for a various sports, outdoor, and fitness activities in North America and internationally. It operates through two segments, Sporting Goods and Activewear. The Sporting Goods segment provides sports apparel, sports equipment, and athletic footwear under the names of Russell Athletic, Spalding, Brooks, American Athletic, Huffy Sports, Mossy Oak, Moving Comfort, Bike, Dudley, and Sherrin. It markets and distributes its products primarily through sporting goods dealers, specialty running stores, department and sports specialty stores, and college stores. The Activewear segment offers basic, performance, and careerwear apparel products, such as t-shirts, sweatshirts and sweatpants, knit shirts, socks, and career wear under the JERZEES and Cross Creek brands through mass merchandisers, distributors, screen printers, and embroiderers. Russell Corporation was founded in 1902 and is headquartered in Atlanta, Georgia.

Date: April 19, 2006
Price per share: $18.32
Market Cap (intraday): 607.93M
Trailing P/E (ttm, intraday): 17.72
Forward P/E (fye 31-Dec-07) 1: 13.47
PEG Ratio (5 yr expected): 0.97
Price/Sales (ttm): 0.42
Price/Book (mrq): 1.03
Enterprise Value/Revenue (ttm)3: 0.56
Enterprise Value/EBITDA (ttm)3: 5.505

Return on Assets (ttm): 4.55%
Return on Equity (ttm): 5.98%

Profit Margin (ttm): 2.40%
Operating Margin (ttm): 6.51%

Source: http://finance.yahoo.com/q/ks?s=RML

My calculations:

Enterprise Value (EV) = $1067M

Free Cash Flow
= $4.53M (2005)
= $45.8M (2004)
= $19.3M (2003)

“Normalised” Free Cash Flow
= $23.2M

Therefore, EV/“Normalised” Free Cash Flow = 46

I like to use EV/Free Cash Flow ratio. However, based on this metric, it seems like Warren Buffett is paying a very high price for this company.

Joel Greenblatt, on the other hand, likes to use EV/EBIT.

EBIT = $84.37M
EV/EBIT = 12.6

By using EV/EBIT, we are getting a decent valuation.

However, there are a few things that I worry about.

Things that I worry about this company:

1. Poor ROE and ROA

2. Poor Profit margin

3. EV/“Normalised” Free Cash Flow

I would be gratefully if fellow readers could give me some comments and reasons why Warren Buffett might be interested in this company, which I may have overlooked. Do send me an email: dahhuilaudavid@gmail.com

All the best,
Dah Hui Lau (David)

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html

Gannett Co; GCI April 19, 2006

Since my last post on Gannett on 18 days ago, Gannett's share has slided to $56.00, which is 8.6% below my recommended buying price of $61.26. I believe that this is even better opportunity to start accumulating shares in this wonderful company.

John W. Rogers Jr. who is the chairman and CEO of Chicago-based Ariel Capital Management, has written in Forbes Magazine for April 24, 2006 edition regarding his thoughts on "Premature Burial" of newspapers companies.

I like a couple of good points that he made.

Among his comments are......

"39 percent of young adults still read a daily paper."

"Despite the Internet's ubiquity, I doubt digital giants like Google and Yahoo can ever replicate the depth of local coverage or level of trust found in a hometown paper. As long as print media control local content, they will distribute it. And don't forget that papers have started Web sites of their own. If an electronic ad is the best way to sell a used Taurus or recruit a sales clerk, then a newspaper company can deliver it to you."

To read John W. Rogers Jr's article, please visit:

http://www.forbes.com/forbes/2006/0424/108.html

To read my analysis on Gannett Co., please visit:

1. Gannett Corp Undervalued at $61.26 March 14, 2006
2. Gannett Corp; GCI April 2, 2006
3. Lau Model Portfolio

Let me end my post with some wisdom from Warren Buffett...

“Be fearful when others are greedy and greedy only when others are fearful.”

"The most common cause of low prices is pessimism -- some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.”

All the best,

Dah Hui Lau (David)

dahhuilaudavid@gmail.com

To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html