r/valueinvesting
A Specific MSFT Breakdown - Rule One Investing
Using the Rule One framework, the author finds MSFT is high-quality but currently lacks the required 50% margin of safety to be a buy.
- MSFT passes the "Big 5" metrics with strong ROIC, sales, EPS, and equity growth.
- Operating cash flow remains very strong, indicating solid underlying business health.
- Buying at the current "Sticker Price" could theoretically yield ~15% annual returns over the next decade.
- Free cash flow growth is mixed and pressured by heavy AI and data-center capital expenditures.
- The stock lacks the required 50% margin of safety according to the Rule One framework, meaning it is not a buy at current prices.
Are you familiar with the book "Rule One Investing" by Phil Town? It basically gives you specific steps for analyzing a company using the Buffett method, and I find it interesting to look at MSFT this way.
Basic gist of this breakdown - MSFT is currently at its "Sticker Price" which (in theory) would result in \~15% returns over the next 10 years if you bought it now. But the "rule one" method applies a 50% margin-of-safety, so it would still have to fall another 50% before it would be a buy...and if that happens, buy big.
How to calculate a Rule One “Sticker Price” + MSFT example
The Rule One framework is basically:
- Check whether the business is high quality.
- Estimate a conservative intrinsic value, called the “Sticker Price.”
- Only buy with a 50% margin of safety.
Part 1: The Big 5 Numbers
Before calculating Sticker Price, Rule One checks whether the business has a real moat. The “Big 5” are:
- ROIC
- Sales growth
- EPS growth
- Equity / book value growth
- Cash flow growth
The rough Rule One target is 10%+ per year over the long term.
How the Big 5 are calculated
For sales, EPS, equity, and cash flow, use Compound Annual Growth Rate:
CAGR = (ending\_value / starting\_value)^(1 / years) \- 1
For ROIC, use an average:
ROIC = net\_income / (equity + long\_term\_debt)
Then average ROIC over the period.
MSFT Big 5
Using Microsoft’s annual data through FY2025:
|Metric|Long window|5y|3y|1y|Read|
|:-|:-|:-|:-|:-|:-|
|ROIC avg|23.7%|29.5%|27.7%|26.3%|Pass|
|Sales growth|13.4%|14.5%|12.4%|14.9%|Pass|
|EPS growth|20.4%|18.8%|12.2%|15.6%|Pass|
|Equity growth|17.1%|23.8%|27.3%|27.9%|Pass|
|Operating cash flow growth|16.9%|17.6%|15.2%|14.9%|Pass|
|Free cash flow growth|12.4%|9.6%|3.2%|\-3.3%|Mixed|
MSFT passes the Big 5 overall. The one caution is free cash flow growth, which has been pressured by the AI/data-center CapEx buildout. Operating cash flow is still very strong, so one might treat FCF as a watch item rather than an automatic fail.
Part 2: Sticker Price
The Sticker Price is a conservative intrinsic value estimate.
General steps
- Start with current TTM EPS.
- Pick a future EPS growth rate.
Use the lower of:
- historical equity/BVPS growth
- analyst consensus EPS growth
- Pick a future PE.
Use the lower of:
- 2 × growth rate
- historical average PE
- Project EPS 10 years out.
future\_eps = current\_eps × (1 + growth\_rate)^(10)
- Estimate the future market price.
future\_price = future\_eps × future\_PE
- Discount back to today.
Rule One usually uses a 15% MARR:
sticker\_price = future\_price / (1.15^(10))
- Apply a 50% margin of safety.
MOS\_price = sticker\_price × 0.5
MSFT Sticker Price example
Current inputs:
- Current MSFT price: $365.46
- TTM EPS: $16.77
- Historical equity growth: \~17.1%
- Analyst EPS growth: \~13.37%
- Growth rate used: 13.37%
- Historical average PE estimate: \~31
- Future PE used: 26.74
- MARR: 15%
- MOS factor: 50%
Step 1: Start with current EPS
current\_eps = $16.77
Step 2: Pick growth rate
historical\_equity\_growth = 17.1% analyst\_growth = 13.37%
growth\_rate = lower of 17.1% and 13.37% growth\_rate = 13.37% = 0.1337
Step 3: Pick future PE
2 × growth\_rate = 2 × 13.37 = 26.74 historical\_avg\_PE ≈ 31
future\_PE = lower of 26.74 and 31 future\_PE = 26.74
Step 4: Project EPS 10 years out
future\_eps = $16.77 × (1 + 0.1337)^(10) future\_eps = $16.77 × 1.1337^(10) future\_eps = $16.77 × 3.5074 future\_eps = $58.82
Step 5: Estimate future market price
future\_price = future\_eps × future\_PE future\_price = $58.82 × 26.74 future\_price = $1,572.81
Step 6: Discount back to today
discount\_factor = 1.15^(10) discount\_factor = 4.0456
sticker\_price = future\_price / discount\_factor sticker\_price = $1,572.81 / 4.0456 sticker\_price = $388.77
Step 7: Apply margin of safety
MOS\_price = sticker\_price × 0.5 MOS\_price = $388.77 × 0.5 MOS\_price = $194.39
Result
MSFT Sticker Price: \~$388.77
MSFT Rule One MOS Buy Price: \~$194.39
Current price: $365.46
So under this version of the Rule One math, MSFT looks like a great business trading below Sticker, but still far above the Rule One MOS buy price.
With that example, I feel like companies that fall this low have something threatening them that puts the entire business at risk.
Companies with strong fundamentals and moats that fall this low usually have a narrative based emotional panic attached to them. Narratives and emotions create market inefficiencies. It’s the entire point of what value investing is trying to exploit.
Ok but in adobes case the panic narrative is probably right. Their top four products are graphic design and acrobat, and if you use acrobat, you’re thinking surely AI can make a less shitty version
But who needs adobe to generate Images or video when. Ai can do it for free
When you subtract stock based compensation from free cash flow, suddenly those “strong fundamentals” in software companies is not so strong looking. A great example is Atlassian! They haven’t made anything innovative lately but reward their staff handsomely at the expense of shareholders.
Thats not how you actually acquire the stock and manage your cost basis according to Town. I took his investment class. That’s the price I’m backing up the truck.
Why are you talking about momentum in a value sub? Buying against momentum is literally how you find value.
Sleepy Truth is right. A classic case of paralysis by analysis. While all the number crunching looks good, my guess is that if MSFT ever got to 198, many of your input numbers would have changed due to economic circumstances that created a fall to that level, and your "Sticker Price" would be lower. Alsomay guess is you will never buy the stock.
you will be waiting a very, very long time to buy anything if you demanded a 50% MoS on top of this.
Yeah, this might have worked 50-80 years ago. Not now. Too many investors, too much money sloshing around, too easy and cheap to transact, info disseminates too fast, etc.
Instead of buying good companies at great price
Buy great companies at great price
Seems like MSFT today checks the latter
The problem isn’t in the formula, the problem is in inflated market with high PE ratios and there are almost no bargain left for the value investors, this is a brilliant approach but the timing isn’t right yet
Buffet holding record high 400B in cash and T-bills for a reason
He sits on record amounts of cash because there is nothing left for him to buy at a discount that would meaningfully move the behemoth that is Berkshire Hathaway. He also sits in cash because of insurance claims.
Comparing MSFT to SAAS companies makes no sense because only a small part of MSFT's value comes from actual SAAS offerings. On top of that, those that do, have much much deeper integration and stickiness (e.g. office has very little real competition).
That is not what OP says.
Only buy with a 50% margin of safety.
Either Adobe will stop growing at this pace or the stock will rebound. The fact that people “don’t like it” now is completely irrelevant if they buy enough of their own stock back.