Much of the value of any company can be attributed to profits expected over the long run. If we discount the next three years of Microsoft’s free cash flow — cash flow after capex — as estimated by Bloomberg, discounted at 8% per annum, we can explain only 6.6% of its current value.
Nvidia has 7.2% of its present value explained this way. The 97% dependence of Tesla on growth beyond the next three years is greater still. By contrast, 27% of oil producer Chevron and 22% of Exxon Mobile can be explained by the immediate short-term outlook. They are clearly value stocks.
Most of the top 40 stocks listed on the JSE fall into the value category. A relatively high 32% of MTN and 28% of Vodacom depend on the next three years of free cash flow, discounted at a far higher 14% per annum, while about 21% of Mr Price and Bidvest can be explained this way. Anglo American at 16.13% is therefore expected to deliver on its restructuring plans.
But there are some notable exceptions on the JSE that are priced for growth. The value of Clicks registers a mere 12% dependence on the next three years of performance, while Shoprite with a 5% ratio is even more of a growth stock by this measure. Note: R100 expected in 20 years’ time is worth R21.50 today at a discount rate of 8%, and only a third as much (R7.28) if we raise the discount rate to 14%.
The way to raise the value of SA economy-facing companies is to lower the discount rate, as faster economic growth would follow. With a stronger economy the numerator of the SA present value calculation — operating profits — would rise and the denominator — the discount rate — would fall, providing a double whammy for present values.
Clearly, the share market takes a long-term view. The observed day-to-day volatility of share prices is explained by the difficulty of forecasting profits or earnings or cash flows over the long run. And the longer the run, the more dependence of present value on future growth, and the more that can go wrong — or right — for shareholders.
There is always the danger that investors will overestimate the growth potential of a growth company, and the disappointment will reveal itself in far lower valuations. But even an expensive growth company by the usual metrics can prove to be a great buy. Take the extraordinary case of Microsoft, a hugely successful company that transformed itself after 2010 and was rerated accordingly.
In January 2010 Microsoft was worth $247bn with a price-earnings ratio of 11. By early 2019 its value had grown to more than $800bn and it was then valued expensively and demandingly of growth at 26 times current earnings. The company is now worth more than $3.3-trillion, an increase of 142%, or an average of 25% per annum, since 2019.
Microsoft is now trading at about 38 times earnings after it reported on July 30. Is it still a buy? The answer will depend on just how well its extraordinary growth in capex continues to transform into profits — by filling the cloud with data centres powered by microchips and by charging for generative IT.
How well this extra capex will be monetised is the essential question. Microsoft’s capex is now 25 times higher than it was in 2010, having increased from $8.943bn to $13.873bn, or 43%, this quarter compared with a year ago. Net cash from operations was up an impressive 29%, accompanied by a large value-adding margin between the return on capital invested, now 28% per annum.
The largely unchanged Microsoft share price (down on Thursday by about 1%) indicates that it has satisfied demanding expectations. Expectations of fast and profitable growth remain as they were. The same question is being asked of all the IT companies that are adding aggressively to their plant and equipment.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
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