Thursday, November 16, 2023

Microsoft During the lost decade

Microsoft (MSFT) generated $1.15/share in Free Cash Flows in 1999 and managed to grow that to $3.45/share in 2012. That's a 200% growth in Free Cash Flow per Share over that time period.

Yet, Microsoft $MSFT stock sold at $58.38/share at the end of 1999. But by the end of 2012, the stock declined by 54% to $26.71/share.

To appease shareholders who hadn't seen any capital appreciation for years, Microsoft started paying dividends in 2003.

A $100 investment in Microsoft at the end of 1999 was worth $51 by the end of 2012, when you account for dividend reinvestment.

Why did Microsoft deliver such terrible performance?

It's because the stock was overvalued in 1999, selling for almost 51 times FCF/Share.

The stock was undervalued in 2012, selling for 8 times FCF. 

Investors were excited about the company's growth prospects in 1999, and willing to pay a massive premium for those cashflows. This is why the valuation multiple was high. This is why returns from 2000 - 2012 were not good. Despite growth in the underlying business, the stock delivered poor performance, due to shrinking in the valuation multiple.

Investors in 2012 saw the company as a value trap, and were willing to give it away at a steep discount. This is why the valuation multiple was low. This is why it delivered great returns from 2012 - 2023.

What is the point of this story?

It is to educate investors about the sources of total returns.

In general, total returns are a function of:

1. Dividends

2. Earnings Per Share/Free Cash Flow Per Share Growth

3. Changes in valuation multiples

The first two items are both portions of the fundamental returns. They are directly related to the performance of the business.

The last item is the speculative return. It is dependent on the "mood" of Mr Market, or the market participants

This story also shows you that the pendulum can swing from a period of excitement, to doom and gloom. 

Even a business that does well over time would have long periods of time where the stock price goes nowhere. Being a long-term investor is not easy, because to earn the great returns of investing, you need  to be sitting through the long periods of poor performance, in order to experience the joys of good performance. There is no way around that.

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