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Estimating Net Profit Margin (MSFT)
The second judgment you will need to predict Microsoft's earnings
tomorrow is an estimate of their net margin for the quarter. Margin
will be affected by their expenses.

It's a long way from the top line of a companies income statement
(Sales) to the very bottom line (Net Income). In between are all the
expenses involved in running the business. As you move down the
income statement, there are stopping points where only certain types
of expenses have been subtracted. At each of these points, different
types of margin can be calculated. For example, gross profit is
the sales of a company minus the cost of whatever it is selling.
Gross profit divided by sales is gross profit margin. Operating
income is calculated by subtracting all the other regular costs of
running the business from the gross profit. We sometimes think of
these costs as "overhead" costs. Operating income divided by sales
gives us Operating margin.

After that are costs (and income) which occur infrequently but are not
unusual for the company. They might affect one quarter but not
another. When we subtract those costs from operating income, we get
pre-tax profit. As it's name indicates, we subtract taxes from
that to get to the bottom line or Net income. Net income is what we
use to calculate the second judgment item we have to make to project
earnings, Net Profit Margin. It is Net Income Divided by Sales. The
second sheet of the attached spreadsheet shows you income statement
information for the past 5 quarters for Microsoft. You'll see the
different Margins highlighted in pink as you move from the top to the
bottom.

When a company discusses it's future expenses, you can get a sense of
which of these expense categories might change and by how much. That
will lead you to judge how the net margin might change in the future
and therefore how it's future earnings might be affected.

As you look at the data for Microsoft, two things pop out at you.
First is the fact that Microsoft has pretty high margins. They are
able to keep a nice percentage of their sales as profits. Second is
the fact that they manage the business well and maintain their margins
pretty consistently. This is encouraging since we are making an
attempt to predict the future using past history.

If you own Microsoft, you should have some sense of what types of
expenses or unusual income they expect in the future so that you can
judge whether you should be a little more conservative or aggressive
in projecting their margins into the future. As with sales
projections, Microsoft management provides a nice discussion of these
factors in the Management Discussion and Analysis section of their
last Quarterly financial statement (June 10-K) and Earnings conference
call.

If you want some other points of reference to help you make the
analysis of Net Profit Margin, ManifestInvesting is using 29% for
their PAR calculation. The analysts at Valueline expect 30.7% for
2011 and 33.1% for the 2013-2015 time frame, Morningstar reports that
the average for the Net Margin for the past 5 years is 28%.

Based on what you see is ahead for Microsoft's business, what Net
Margin to you think they'll be able to achieve in the future? What do
you think they'll report they achieved during the first quarter
earnings announcement on Thursday? Plug this into the spreadsheet
along with your projection of sales growth and check in on Thursday to
see how close your projection came to their report!

I hope you'll participate in our contest by entering your projections
Thursday before 2PM EDT here:

https://spreadsheets.google.com/viewform?formkey=dEtYZU54RHN4RDhKa3BxWjF1LVJDemc6MA

It's easy to try. Don't forget you might earn $20 bivio bucks toward
your next subscription renewal if your estimate comes closest to what
is reported!

--
Laurie Frederiksen
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