Microsoft Corporation (MSFT) and Costco Wholesale Corporation (COST) Go Head-to-head

Microsoft Corporation (NASDAQ:MSFT) shares are up more than 3.48% this year and recently decreased -3.01% or -$2.75 to settle at $88.52. Costco Wholesale Corporation (NASDAQ:COST), on the other hand, is down -1.81% year to date as of 04/02/2018. It currently trades at $182.75 and has returned 1.06% during the past week.

Microsoft Corporation (NASDAQ:MSFT) and Costco Wholesale Corporation (NASDAQ:COST) are the two most active stocks in the Business Software & Services industry based on today’s trading volumes. Investor interest in the two stocks is clearly very high, but which is the better investment? To answer this question, we will compare the two companies across growth, profitability, risk, and valuation metrics, and also examine their analyst ratings and insider activity trends.

Growth

The ability to consistently grow earnings at a high compound rate is a defining characteristic of the best companies for long-term investment. Analysts expect MSFT to grow earnings at a 11.07% annual rate over the next 5 years. Comparatively, COST is expected to grow at a 11.74% annual rate. All else equal, COST’s higher growth rate would imply a greater potential for capital appreciation.

Profitability and Returns

Growth doesn’t mean much if it comes at the cost of weak profitability. To adjust for differences in capital structure we’ll use EBITDA margin and Return on Investment (ROI) as measures of profitability and return. , compared to an EBITDA margin of 4.05% for Costco Wholesale Corporation (COST). MSFT’s ROI is 11.70% while COST has a ROI of 16.00%. The interpretation is that COST’s business generates a higher return on investment than MSFT’s.

Cash Flow

Cash is king when it comes to investing. MSFT’s free cash flow (“FCF”) per share for the trailing twelve months was +0.27. Comparatively, COST’s free cash flow per share was -1.40. On a percent-of-sales basis, MSFT’s free cash flow was 2.31% while COST converted -0.48% of its revenues into cash flow. This means that, for a given level of sales, MSFT is able to generate more free cash flow for investors.

Liquidity and Financial Risk

Balance sheet risk is one of the biggest factors to consider before investing. MSFT has a current ratio of 2.90 compared to 1.00 for COST. This means that MSFT can more easily cover its most immediate liabilities over the next twelve months. MSFT’s debt-to-equity ratio is 1.14 versus a D/E of 0.00 for COST. MSFT is therefore the more solvent of the two companies, and has lower financial risk.

Valuation
MSFT trades at a forward P/E of 22.60, a P/B of 8.71, and a P/S of 6.90, compared to a forward P/E of 23.81, a P/B of 6.83, and a P/S of 0.59 for COST. MSFT is the cheaper of the two stocks on an earnings basis but is expensive in terms of P/B and P/S ratio. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Analyst Price Targets and Opinions
A cheap stock isn’t a good investment if the stock is priced accurately. To get a sense of “value” we must compare the current price to some measure of intrinsic value such as a price target. MSFT is currently priced at a -15.33% to its one-year price target of 104.55. Comparatively, COST is -12.75% relative to its price target of 209.46. This suggests that MSFT is the better investment over the next year.
Risk and Volatility

No discussion on value is complete without taking into account risk. Analysts use a stock’s beta, which measures the volatility of a stock compared to the overall market, to measure systematic risk. A stock with a beta above 1 is more volatile than the market. Conversely, a beta below 1 implies a below average level of risk. MSFT has a beta of 1.07 and COST’s beta is 0.97. COST’s shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

Short interest, or the percentage of a stock’s tradable shares currently being shorted, is another metric investors use to get a pulse on sentiment. MSFT has a short ratio of 1.71 compared to a short interest of 2.80 for COST. This implies that the market is currently less bearish on the outlook for MSFT.

Summary

Microsoft Corporation (NASDAQ:MSFT) beats Costco Wholesale Corporation (NASDAQ:COST) on a total of 8 of the 14 factors compared between the two stocks. MSFT is more profitable, has higher cash flow per share, has a higher cash conversion rate and higher liquidity. MSFT is more undervalued relative to its price target. Finally, MSFT has better sentiment signals based on short interest.

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