Tickers in this Article: MSFT, INTC, GOOG, CSCO
Microsoft (Nasdaq:MSFT) shares trade for $27 a share, effectively valuing the company at 10 times trailing earnings and 8.6 times forward earnings. On that simple metric, MSFT appears to be a good value. The earnings yield, or the inverse of the P/E ratio, is 10 to 13% over the course of the year. That's an excellent figure for a blue-chip company in today's low-rate, low-growth environment. (To help you invest using ratios, read How To Use The P/E Ratio And PEG To Tell A Stock's Future.)

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Undervalued or Just Cheap Stock Price
Yet investors should look a little deeper into determining whether Microsoft is truly a cheap business. The simple definition of a business's value is the present value of all future cash flows expected to be generated by that business. In terms of cash flow, Microsoft has few rivals. Over the past three years, MSFT has, on average, generated over $20 billion in free cash flow per year. It's beyond the scope of this column to go into the intricacies of a discounted cash flow analysis, but some useful assumptions can be made.

Microsoft's Windows platform is quite simply a cash cow. For years, free versions of Windows and Office have been offered and yet have failed to penetrate the company's market share. The company's newest version, Windows 8, will be out in the near future. So with a fair degree of confidence, one can assume that future cash flows will continue at Microsoft. Besides Windows, the company is succeeding with its Xbox game platform. The Bing search engine is still way behind Google (Nasdaq:GOOG) but Microsoft certainly has the balance to grow its business outside of Windows.

Simple Math
It seems fair that given the stability of Softy's cash flows, a multiple of 9 times free cash flow is acceptable, or $180 billion based on $20 billion a year on average. Of course, one has to then assign a terminal value (TV) to Microsoft. Microsoft generates an ROE of over 40%; unfortunately, that return is only viable on a small fraction of the company's cash today. Microsoft is no longer the high-growth tech start up is was back in the 1990's. Most of its cash goes to the balance sheet, paying dividends, or as we've seen recently, paying a rich price for Skype. Microsoft can afford to buy Skype without any significant dent in its intrinsic value because of its immense cash flow generation. Assuming a conservative multiple of 8 times for a TV based on 2016 free cash flow (FCF) (I'll spare you the math), one can derive at a TV of $90 to $110 billion. Adding the $180 billion gives a price value of $270 billion to $330 billion. Using the median figure of $300 billion gets you a share price of nearly $36. Today shares trade for $27 and yield 2.4%

Given the pristine balance sheet and immense cash generation, Microsoft is a high-quality business in a low-quality global investing climate. Its cousins Cisco (Nasdaq:CSCO) and Intel (Nasdaq:INTC) are also intriguing for similar reasons: quality cash flow generation, impeccable balance sheets and historically low stock prices. Sure, these names aren't as exciting as they once were, but their durability in this fragile economy is anything but boring.

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