Microsoft Corporation (MSFT) vs. Microchip Technology Incorporated (MCHP): Breaking Down the Two Hottest Stocks

Microsoft Corporation (NASDAQ:MSFT) shares are up more than 33.70% this year and recently decreased -0.03% or -$0.04 to settle at $114.37. Microchip Technology Incorporated (NASDAQ:MCHP), on the other hand, is down -10.21% year to date as of 09/28/2018. It currently trades at $78.91 and has returned -4.64% during the past week.

Microsoft Corporation (NASDAQ:MSFT) and Microchip Technology Incorporated (NASDAQ:MCHP) are the two most active stocks in the Business Software & Services industry based on today’s trading volumes. Investors are clearly interested in the two names, but is one a better choice than the other? We will compare the two companies across growth, profitability, risk, valuation, and insider trends to answer this question.

Growth

Companies that can increase earnings at a high compound rate over time are attractive to investors. Analysts expect MSFT to grow earnings at a 12.42% annual rate over the next 5 years. Comparatively, MCHP is expected to grow at a 16.10% annual rate. All else equal, MCHP’s higher growth rate would imply a greater potential for capital appreciation.

Profitability and Returns

Growth isn’t very attractive to investors if companies are sacrificing profitability and shareholder returns to achieve that growth. We will use EBITDA margin and Return on Investment (ROI), which control for differences in capital structure between the two companies, to measure profitability and return., compared to an EBITDA margin of 37.93% for Microchip Technology Incorporated (MCHP). MSFT’s ROI is 17.60% while MCHP has a ROI of 15.10%. The interpretation is that MSFT’s business generates a higher return on investment than MCHP’s.

Cash Flow

The amount of free cash flow available to investors is ultimately what determines the value of a stock. MSFT’s free cash flow (“FCF”) per share for the trailing twelve months was +0.54. Comparatively, MCHP’s free cash flow per share was +0.51. On a percent-of-sales basis, MSFT’s free cash flow was 3.77% while MCHP converted 3.02% 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

Liquidity and leverage ratios are important because they reveal the financial health of a company. MSFT has a current ratio of 2.90 compared to 1.30 for MCHP. This means that MSFT can more easily cover its most immediate liabilities over the next twelve months. MSFT’s debt-to-equity ratio is 0.97 versus a D/E of 2.22 for MCHP. MCHP is therefore the more solvent of the two companies, and has lower financial risk.

Valuation

MSFT trades at a forward P/E of 23.22, a P/B of 10.62, and a P/S of 7.90, compared to a forward P/E of 10.34, a P/B of 3.62, and a P/S of 4.44 for MCHP. MSFT is the expensive of the two stocks on an earnings, book value and sales basis. 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

Just because a stock is cheaper doesn’t mean there’s more value to be had. In order to assess value we need to compare the current price to where it’s likely to trade in the future. MSFT is currently priced at a -6.12% to its one-year price target of 121.82. Comparatively, MCHP is -31.12% relative to its price target of 114.56. This suggests that MCHP is the better investment over the next year.

Risk and Volatility

Analyst use beta to measure a stock’s volatility relative to the overall market. Stocks with a beta above 1 tend to have bigger swings in price than the market as a whole, the opposite being the case for stocks with a beta below 1. MSFT has a beta of 1.27 and MCHP’s beta is 1.06. MCHP’s shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

Comparing the number of shares sold short to the float is a method analysts often use to get a reading on investor sentiment. MSFT has a short ratio of 1.75 compared to a short interest of 11.52 for MCHP. This implies that the market is currently less bearish on the outlook for MSFT.

Summary

Microchip Technology Incorporated (NASDAQ:MCHP) beats Microsoft Corporation (NASDAQ:MSFT) on a total of 7 of the 14 factors compared between the two stocks. MCHP generates a higher return on investment and is more profitable. In terms of valuation, MCHP is the cheaper of the two stocks on an earnings, book value and sales basis, MCHP is more undervalued relative to its price target. Finally, BMY has better sentiment signals based on short interest.

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