Microsoft - Buy side stock report issued on May 8, 2016

Executive Summary: During 2016 Q1, Microsoft returned $6.5 billion to shareholders in the form of share repurchase and dividends. Businesses everywhere are using the Microsoft Cloud as their digital platform. With the combination of Cloud and Windows 10 adaptation, Microsoft consistently adding value to shareholders. Microsoft has a healthy portfolio of products (Office 365, Windows, Azure and SharePoint to name few) to enhance performances across the company. It has diversified earnings potential across its core business Windows and Office products and accelerated growth in Cloud based services. Microsoft is heavily investing in niche areas such as Cloud and Augmented Reality; these two niche technologies will have substantial growth opportunities for next decade. With recent change in CEO, Microsoft has redefined its strategy and clearly sent a positive signal to shareholders. With sixteen percent growth for the past year alone, Microsoft stands at third largest publicly traded company behind Alphabet and Apple. Valuation:  Microsoft currently trades at multiple of 35 where the industry average is 34, and healthy 5-year dividend payout ratio 2.67% whereas industry average is barely 0.3%. Consistently beating industry and sector in EBITDA with gross operating margin of 30.1% compared with 5.0% of industry margin and 18.5% of sector margin. Under the discounted cash flow (DCF) model Microsoft terminal value is $521 billion. Summary DCF Valuation   DCF Enterprise Value $427,980 23.2x   Less: Net Debt $61,028   Equity Value $489,008   Shares 8,130   DCF Value per Share $60.15 21.5x Forward DCF Equity Sensitivity Analysis WACC Growth 7.0% 9.0% 11.0% 2.0%  $73.44 53.86 43.02 3.0% 87.67 60.15 46.43 4.0% 111.39 68.96 50.82 Moat: During past 13 years Microsoft’s average return on equity was 34.26% that was 72% higher than the industry average. Microsoft's wide economic moat is a combination of the Windows operating system, Office productivity suite, and the Windows Server, database, and cloud businesses. Microsoft has adjusted its strategy as enterprise workloads continue to shift to the cloud, away from the client/server model. Billions of dollars invested in the Azure platform are beginning to pay off, and its more open approach to delivering software in the cloud will prevent the firm from material technology disruption. Recommendation: I have a buy recommendation, with a 1-year price target (2017Q1) of $60.15. The one-year price target implies a 2016 P/E of 23.2x, with impressive 19 percent of increase in share price. Under CEO Satya Nadella’s leadership, Microsoft is reinventing itself into multiple new business platforms. While making Office suits products from desktop based to cloud model, Azure, and Augmented Reality, company value with multiples of 23x is very reasonable for next four to five years.