Understanding Microsoft’s Value Proposition in the US Software Space

Microsoft’s scale in systems software

Previously, we discussed analysts’ recommendations for Microsoft (MSFT) stock following its fiscal 1Q18 earnings announcement. As of October 30, 2017, Microsoft, with a market cap of ~$647 billion, continued to be the largest software player. Oracle (ORCL), with a market capitalization of ~$210 billion, came in second. With market caps of ~$21 billion each, ServiceNow (NOW) and Red Hat (RHT) placed third and fourth, while Tableau Software (DATA) held fifth place.

Understanding Microsoft’s Value Proposition in the US Software Space

Valuation and dividend yields

Let’s compare Microsoft’s and peers’ EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiples. EV refers to the market value of a company’s debt and equity, excluding cash and cash equivalents. Therefore, EV-to-EBITDA multiples consider the valuation of an overall company, not just its equity.

On October 30, Microsoft was trading at a forward EV-to-EBITDA multiple of ~12.6x. In comparison, Oracle’s multiple was ~9.8x and Red Hat’s was ~23.8.

Microsoft’s forward annual dividend yield was ~2.0% as of October 30, higher than Oracle’s ~1.5%. Dividend payout indicates how much a company pays in dividends in relation to its stock price. Microsoft stock’s surge has thereby reduced its dividend yield. Dividends are preferred by investors and shareholders as they view it as steady income, especially amid increasing uncertainty and volatility.

Currently, ServiceNow and Red Hat don’t pay dividends. Investors keen on gaining diversified exposure to select US software companies could consider the SPDR S&P 500 ETF (SPY) (SPX), which has an 8.0% exposure to the application software industry.