This corporate research and valuation project, which is fundamental in essence, shall be based on the “Top-Down” approach (any exception shall be justified and approved by the instructor)

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This corporate research and valuation project, which is fundamental in essence, shall be based on the “Top-Down” approach (any exception shall be justified and approved by the instructor). This approach shall begin with an examination of the overall macroeconomic environment and outlook, the industry of the selected company and then draw some implications about the prospects for the future operations and performance of the company. THE COMPANY IS MICROSOFT CORPORATION.

Brief analysis of the overall macroeconomic environment

Corporate Background, Structure, and Basic Business Information

A brief history of your company, i

Corporate Governance Analysis

Does the company have a clear separation between ownership and management? Between Chairman of the Board of Directors and CEO?

How responsive is the management to shareholders?

Stockholding Analysis – What is the breakdown of the company’s stockholders, in terms of percent ownership by the insiders, institutional, and individual investors?

CORE RESEARCH QUESTIONS AND VALUATION Company: MICROSOFT CORPORATION Background Information This corporate research and valuation project, which is fundamental in essence, shall be based on the “Top-Down” approach (any exception shall be justified and approved by the instructor). This approach shall begin with an examination of the overall macroeconomic environment and outlook, the industry of the selected company and then draw some implications about the prospects for the future operations and performance of the company. Brief analysis of the overall macroeconomic environment. Analyze the U.S. and relevant global macroeconomic outlook. Determine the significant macroeconomic factors and developments that are most likely to affect the firm’s operations and performance? Clearly explain the connections. Identify whether the company’s operations or performance are cyclical or non-cyclical (i.e., whether they are sensitive the overall economy or business cycles? Why? (Some analysis of correlation, regression or the company’s stock beta, β, may be used as identification strategy). For example, perform a correlation analysis and a regression analysis relating “Sales growth rate to GDP growth rate” or “Earnings growth rate to GDP growth rate.” Brief industry analysis – Present a concise analysis of the sector or industry in which the selected firm operates. What is the firm’s sector or industry? Identification shall be based on the 6-digit North American Industry Classification System – NAICS code, structure, relative importance in the U.S. economy, main issues it faces). Describe the industry outlook – whether the industry is growing, stagnant or declining. Why (provide evidence)? Analyze any critical trends or economic forces that affect the profits in the company industry. One of the popular models the teams can use in this analysis is the Michael Porter’s Five-force framework that identifies the economic forces that affect industry profits, which are (1) Internal rivalry, (2) Entry, (3) Substitutes and complements, (4) Supplier power and (5) Buyer power. Corporate Background, Structure, and Basic Business Information A brief history of your company, including: When was the company created? Any subsequent changes in the name, focus or structure? When did the company go public (IPO – Initial Public Offering) What is the geographic distribution of the company’s activities – domestic (U.S.) and/or global/international. What is the company’s number of employees? Principal “Business Model and/or Strategy” of the company Briefly describe the core activities of the company and how it generates most of its core revenues. Is the company a conglomerate? Is yes, what are its different lines of products? What differentiates the company from its peers in the industry (its competitive advantage or economic moat)? This should include identification of the key drivers or factors for the success or challenges in in this industry. Corporate Governance Analysis Does the company have a clear separation between ownership and management? Between Chairman of the Board of Directors and CEO? How responsive is the management to shareholders? How does the company interact with the financial markets? How do investors, analysts and other market participants obtain information about the company (Website? Conference Calls? Reports?)? What are the positions, names, and compensation structure of the top 3 key executives (e.g., CEO, CFO, etc.)? [Consult company’s websites and reports filed with the SEC.] Is there any recent issues raised about governance, which may have implications on the company future operation, performance or valuation? Stockholding Analysis – What is the breakdown of the company’s stockholders, in terms of percent ownership by the insiders, institutional, and individual investors? Corporate Performance and Other Financial Metrics Time series analysis of the company share price. Plot monthly time series (price against days) of the company’s share price over the most recent 60 months. The team may also conduct a trend analysis (regression) of the company stock’s share price; estimate the average annual growth rate during the period under consideration. Provide a plausible explanation of one or two largest swings in the share price during the period under consideration. Describe whether the company is a value or a growth company (stock)? This could be achieved by examining whether any of the following valuation ratios – Price-to-Earnings (P/E), Marketto-Book ratio or Price-to-Book (P/B), Price-to-Sales (P/S), Price-to-Cash Flow (P/CF) – is low or high. In addition, the team shall examine whether the company’s revenues and earnings growing, stagnant or falling, compared to peers and/or the industry? Risk Analysis What is the firm’s general/overall risk profile? Business risk? Operating risk? Financial risk (e.g., debt ratio)? What is the value of the company’s systematic risk, as measured by stock beta? What does this value suggest about the sensitivity of the company’s stock returns to the returns of the relevant market index? Where does most of the risk come from (market, firm, industry, economy, or currency)? How has the risk profile changed over time? How? Return Analysis What is the company’s return? Return on Equity (ROE), Return on Assets (ROA), Return on Invested Capital (ROIC), and Economic Value Added (EVA)? What the return (Total Shareholder Return, TSR) one would have earned if he/she had invested in the company’s stock, say 12 or 24 months ago? Would have this investment underor out-performed the market? Would the performance be attributable to management or simply to the overall market performance? Other Key Financial Metrics – Company versus peers or Industry Present a Table of the following key financial statistics: Example: growth rates of the firm’s market capitalization, sales revenue, earnings, dividend payout ratio and yield, share price. Compare each metrics to firm’s own average or trend and to industry or peers’ average. (Consult the handout on Google vs. Alibaba, which I will post, for some guidance) Briefly comment of the most “striking” financial statistics, indicating why you believe they deserve special attention. 10-K. Is there anything that would cause investors in the company to be concerned about, based on reading of the 10-K reports that the company files annually with the U.S. Securities and Exchange Commission (SEC)? 1. Brief analysis of the overall macroeconomic environment. Current US and global macroeconomic outlook is uncertain but likely extremely negative due to the impact of the Covid-19 pandemic which is currently causing severe lockdowns in most developed economies. This crisis could potentially kick off a major economic downturn or simply be a speed bump to economic growth depending on a number of factors including: government policy towards lockdowns, time needed to develop a vaccine, central bank interventions and potentially geopolitics. Relations between the EU, US and China (collectively the three largest economies in the world) are currently strained, which could exacerbate the global trade tensions which had occupied much of the news in the finance world in recent years. Luckily for the York Water Company, there is little chance of harm to it’s business due to the nature of its products and it’s regulated business model. Additionally York Water is largely immune to the headlines about drought in the American Southwest as it only operates in the decidedly rainy Southern Pennsylvania region (an area which is also insulated from potential climate change related sea level rise by it’s significant distance from the coast and it’s elevation). 2. Industry Analysis York Water is engaged in the water utility industry, NAICS industry code 221310. It’s operations are largely non-cyclical as it’s core products are essential to the modern hygienic lifestyle, so essential that the government has determined them too important to leave unregulated as people cannot simply stop drinking water and are unlikely to start building outhouses anytime soon (this would indicate a very severe regression in economic well being, akin to letting the aqueducts crumble). The non-cyclical nature of it’s business is evidenced by it’s low Beta of .15 (low even within it’s industry), people simply do not stop using York Water’s products/services regardless of economic conditions and investors seem to trust it’s stable payouts enough to hold the stock through market declines. According to data from the NYU Stern School of Business, both the Utility and Water Utility Industries achieved low Betas over the previous five years, this is due to the regulated nature of many of these firm’s business model, high degree of market power as the sole provider in a given area and essential nature of their products. (Source NYU Stern School) This low Beta indicates the steady growth in revenues and profits produced within this industry and a certain degree of insulation from market volatility that tends to affect cyclical or growth oriented businesses more significantly. 3. Corporate Backround, Stucture and Basic Business Information Business Model and Stategy York Water distributes fresh drinking water directly to consumers through it’s two pipe systems, collects wastewater directly from consumers through it’s two collection systems and owns two wastewater treatment plants. York Water is the sole company providing these services in a total of 48 municipalities in the York and Adams Counties in Pennsylvania. York Water is an investor owned utility organized as a public corporation and is listed on the NASDAQ stock exchange. The company is regulated by the Pennsylvania Public Utility Commission which determines many aspects of it’s business including the price it can charge to consumers, debt levels or equity issuances, territory in which it can operate and the counter parties with which it can interact. As such, York’s business is made very simple in terms of operations as there are not many activities which are not determined by the government. Additionally York has a monopoly on water services within it’s territory which combined with it’s other attributes and a distribution system hardwired into consumer’s homes nets a very stable firm with consistent revenues and fairly consistent profits. In this sense York Water is very similar to it’s “competitors” within the industry, but it must be stressed that due to the natural monopoly nature of this industry (it would be prohibitively expensive to build two water pipe systems to compete for the same customers, or two railroads for that matter or two electrical grids) York Water has no local firm offering the same product to the same consumers. This monopoly power is evidenced by York Water’s high Operating and Profit margins of 43.3% and 27.92% respectively, the profitability of York Water’s investments is largely determined by the regulators who in turn prevent York Water from setting exorbitant prices for their essential services. Overall the arrangement leads to a cozy operating environment for York Water, largely devoid of the competition normally found in free markets. Like most of it’s competitors, one of the few decisions that management can make independent of regulators is capital expenditure. Operating Cash Flow of 18.88M was not enough to cover the large capital investments that York Water is currently making to maintain/improve the critical infrastructure that it owns, producing a levered free cash flow of -3.45 million dollars in the trailing twelve month period (Yahoo Finance). While this state of affairs is not sustainable indefinitely, it does bear noting that these investments will likely lead to returns in the long run as management passes these investment costs on to consumers at regulated rates. (Souce: Yahoo Finance) Corporate History York Water was founded in 1816 by local business figures who established a log pipe system for their homes (16,000 logs had to be floated down the Susquehanna river for it’s initial construction, 35 homes were connected in the first year) and has the distinction of being the company with the longest ongoing dividend payout in American history, consecutively paying dividends for over two centuries regardless of wars or recessions or plagues (notable given the current macroeconomic outlook being so affected by a pandemic the likes of which hasn't been seen in a century, one that York Water Company weathered just fine in addition to earlier outbreaks of disease like typhoid). York Water has been in business for so long that no IPO data seems to exist, more most of it’s history the company’s stock was traded OTC until Listing on the NASDAQ exchange in 2001 (though this itself is poorly documented, only referenced in the company’s website under the company history section in 2006 when the entry mentions the 5th anniversary of the listing) In the 2019 Annual report the company noted the discover of one of it’s original hollowed log pipes laid in 1816 during a capital expansion project illustrates the long term continuity of this business, it has with increasing sophistication been dooing the same thing for nearly two centuries: providing the basic running water services that have been the hallmark of civilization for millennia. Corporate Governance and Stockholding analysis. York Water Company, though originally founded by a few businessmen to serve their personal needs, is now primarily owned by outside investors. Insider ownership represents only 1.27% of the firm while 42.8% of the firm is owned by institutions and the rest is owned by the general public, though it should be noted that Insider ownership has been increasing recently as insider purchases outweigh sales. York Water Company’s largest shareholders, like most public companies, are the Vanguard Group and BlackRock Inc. which are the world’s two largest asset managers and operate passively managed index funds on behalf of other institutions and individual savers. Additionally it’s fourth Largest institutional shareholder is Renaissance Technologies, notable for being a highly secretive and successful quantitative hedge fund operated by top mathematicians and scientists. York Water Company has a clear separation between ownership and management due to the existence of an independent board of directors which oversees York Water’s corporate governance and performance on behalf of other shareholders to ensure their long term interests are being considered by management. The Board of directors is composed of non company executives, some of whom serve on other boards (primarily of other local Pennsylvanian firms) and some solely on the board of York Water Company. The top three executives are Joseph Thomas Hand (CEO, President, and Director), Mathew E. Poff (CFO and Treasurer) and Mark A Wheeler (COO and Secretary), Mr Hand was recently promoted to the CEO position after the retirement of previous CEO Jeffery R Hines. The Firm publishes an annual report covering financial and operating performance as well as having an annual meeting, to be held virtually in 2020 due to the COVID-19 pandemic. Due to York Water’s small market capitalization it is loosely followed by professional analysts but is included in certain stock indexes such as those that track utilities or water utilities more specifically. 4. Corporate Performance and Other Financial Metrics A. ? The red line is the trend analysis for YORW (found using least squares regression). It indicates a steady growth of YORW the past 5 years. The CAGR (Compounded Annual Growth Rate) indicated a 12.96% growth rate after calculations, a modest annual increase. ? There aren’t any incredibly large swings of price in the 5Y of YORW shown. This is due to the fact that most Utility Companies’ stocks are pretty non volatile. Most areas only have one company for their utilities, as competition amongst utility companies would be detrimental for all. Thus, they are almost monopolistic in their respective operating areas. ? However, in 2017, YORW stock plunged nearly 12% in May. YORW did not release their performance and first quarter earnings until May 2nd, so it is unlikely the earnings release played a role in the decline. It is most likely due to two reasons. The first reason is the over valuation of all water utility companies in that time period. YORW believed their Price-to-Earnings basis to be 35.2 as well as their Earnings-per-Share to grow to 4.9% per year over the next 5 years. It was due to this overvaluation that the price declined. Also, YORW at the same time was reporting an increase in the amount of lead in their water, leading to some concerned investors, as well as the price decline. B. YORW (The York Water Company) ? Price-to-Earnings ratio (P/E) = Price per Share / Earnings per Share ? Price-to-Earnings ratio (P/E) for YORW 2019 = $44.40 / $1.11 = 40 ? Market-to-Book ratio (P/B) = Market Value of Equity 2019/ Book Value of Equity 2019 ? Market-to-Book ratio (P/B) for YORW 2019 = $528.10 million / $134.185 million = 3.936 ? This indicates the stock is a Growth stock due to the high P/B ratio of 3.936. CWT (California Water Service Group) ? Price-to-Earnings ratio (P/E) = 42.03 ? Market-to-Book ratio (P/B) = $2.25 billion / $780 million = 2.885 ? CWT is also expected to grow by investors and considered a Growth stock. MSEX (Middlesex Water Co.) ? Price-to-Earnings ratio (P/E) = 28.41 ? Market-to-Book ratio (P/B) = $1.02 billion / $325.876 million = 3.13 ? MSEX is also expected to grow by investors and considered a growth stock. ? The current Price-to-Earnings ratio for the Utility sector is 28.23 (Analysts predict it will rise to 39.18). ? The current Price-to-Earnings ratio for the water utility sector is 46.15 (48.13 trailing) ? Thus The York Water Company is currently performing as well as water utility should be and having an influx of growth. It also appears that other utility companies are experiencing some growth as well. Revenues and Earnings YORW (The York Water Company) ? 2019 Sales/Revenue = $51.78 million ? 6.48% increase from 2018 sales at $48.437 million. ? Sales/Revenues has seen a 9.962% increase over the past 5 years. ? 2019 EBIT (Earnings Before Interest and Taxes) = $23.786 million ? 5.636% increase from 2018 EBIT at $22.517 million ? EBIT has seen a 4.964% increase over the past 5 years. CWT (California Water Service Group) ? 2019 Sales/Revenue = $714.557 million ? 2.34% increase from 2018 sales at $698.196 million. ? Sales/Revenues has seen a 21.447% increase over the past 5 years. ? 2019 EBIT = $115.692 million ? -10.406% decrease from 2018 EBIT at $129.129 million ? EBIT has seen a 14.549% increase over the past 4 years. ? Market data for 2015 EBIT was missing on numerous informational finance sites and databases. MSEX (Middlesex Water Co.) ? 2019 Sales/Revenue = $134.598 million ? -2.52% decrease from 2018 sales at $138.077 million. ? Sales/ Revenues has seen a 6.803% increase over the past 5 years. ? 2019 EBIT = $35.520 million ? -4.367% decrease from 2018 EBIT at $37.142 million ? EBIT has seen a -0.893% decrease over the past 5. years. ? Compared to peers in the water utility sector, YORW is performing at a more efficient rate with growth in Sales/Revenues and Earnings, whereas MSEX and CWT have shortcomings in their Sales/Revenues and Earnings. ? CWT’s EBIT has decreased over the past year ? MSEX’s Sales/Revenues and EBIT have decreased over this past year, as well as their EBIT for the past 5 years. C. Risk Analysis Risk Profile YORW (The York Water Company) Debt Equity (D/E) ratio: ? Total Liabilities YORW 2019 = $229.344 million ? Total Equity YORW 2019 = $134.185 million ? Debt-Equity ratio (D/E) = Total Debt / Total Equity ? Debt-Equity ratio (D/E) for YORW 2019 = $229.344 million / $134.185 million = 1.709 ? Currently the average Debt-Equity ratio for utilities is 2.54, dropping from an all time high of 2.55 in Q4 2019. ? Compared to the sector, YORW has a lower than average Debt-Equity ratio at 1.709 ? YORW is able to run its operations with less borrowed money compared to the industry, thus YORW runs a smaller chance of bankruptcy compared to peers. ? Beta 5Y monthly (Value of Company's systematic risk) = 0.29 ? Beta is a measure of a stock’s volatility in relation to the overall market. ? Betas that are lower than 1 usually indicate a stock with a lower volatility; that is the price of the stock fluctuates less than the market. ? Beta is generally a better indicator for short term risk. ? A low Beta of 0.29 is expected of YORW as water utilities generally are very non-volatile securities as explained earlier. ? This also suggests that the stock’s returns compared to the returns of the relevant market index will not be as large and as rapidly gained. However, the investment of YORW on a short-term basis is a relatively safe one and will add to your portfolio. ? Most of the risk for YORW comes from the firm and industry aspects of the utility company. ? Efficient Use of Resources ? Water utility companies use a large amount of inputs from chemicals, are energy intensive, and manage water, a highly valuable and sometimes scarce resource. ? The efficient use of resources will be a strong tool in reducing the volatility of earnings and controlling operating costs. It will also be a strong tool in preserving and protecting environmental conditions. ? Evolving Environmental Regulations ? Water utility companies are in charge of providing clean, safe, drinking water to our homes as well as the removal of all wastewater. ? If environmental regulations tighten regarding wastewater removal and other aspects of water utility companies, operating costs and capital expenditures can increase. Leading to a decrease in earnings. ? The Cost of Providing these Services to the Public ? If the cost of providing water and removing wastewater is too expensive for the respective operating area of the water utility company, no one will be able to afford the services of the company, thus greatly affecting the sustainability of the share price. ? In order to prevent this, relations must be maintained with the community, and business models must change to the increasing need for water efficiency ? The risk profile for water utility companies has definitely changed over time to become more risky than it once was. Initially, water utility companies mainly focused on just the collection and disposal of wastewater as well as the creation and investment of reservoirs and pipelines. However, around the 1960’s and 1970’s, environmental regulations for utility companies began to tighten, and newly improved water systems required large amounts of maintenance to keep their functionality and adhere to new regulations. This led to an increase in the operating costs of water utility companies. At the same time, the standards for sewers and drainage services improved; all aimed at reducing pollution. One of the biggest causes for a change in the risk profile for water utility companies over time is population growth. More people require access to water services than they did 100 years ago, thus the costs of providing water and maintaining the infrastructure necessary to provide that water has increased greatly. The water utility company must balance all this while also being able to provide an affordable price for customers. Failure to do so can lead to fluctuations in earnings and increased volatility of the respective share price. D. Return Analysis Return on Equity YORW (The York Water Company) ? Return on Equity = Net Income / Book Value of Equity ? Return on Equity for YORW 2019 = $14.402 million / $134.485 million = 10.709% CWT (California Water Service Group) ? Return on Equity for CWT 2019 = $63.116 million / $780 million = 8.091% MSEX (Middlesex Water Co.) ? Return on Equity for MSEX 2019 = $33.888 million / $325.876 million = 10.399% ? In the Q4 2019, Return on Equity for the Water Utility industry was 10.23% ? As we can see The York Water Company is performing right alongside industry averages. Return on Assets YORW (The York Water Company) ? Return on Assets = ( Net Income + Interest Expense ) / Book Value of Assets ? Return on Assets for YORW 2019 = ($14.402 million + $4.903 million) / $363.529 million = 5.310% CWT (California Water Service Group) ? Return on Assets for CWT 2019 = ( $63.116 million + $41.221 million ) / $3.212 billion = 3.248% MSEX (Middlesex Water Co.) ? Return on Assets for MSEX 2019 = ( $33.888 million + $7.264 million ) / $909.878 million = 4.523% ? In the Q4 2019, Return on Assets for the Water Utility Industry was 2.92% ? As we can see The York Water Company is performing better than its competitors regarding Return on Assets, as well as besting the industry itself. This displays that YORW is effective in converting the money it invests into net income. Return on Invested Capital YORW (The York Water Company) ? Return on Invested Capital = ( EBIT (1 - Tax Rate ) ) / ( Book Value of Equity + Net Debt) ? Return on Invested Capital for YORW 2019 = 6.43% CWT (California Water Service Group) ? Return on Invested Capital for CWT 2019 = 4.18% MSEX (Middlesex Water Co.) ? Return on Invested Capital for MSEX 2019 = 7.01% ? In the Q4 2019, Return on Invested Capital for the Water Utility Industry was 5.07% ? YORW is performing well according to industry averages regarding Return on Invested Capital, and displays that The York Water Company is creating value for the company and efficiently using it’s money to generate returns. Total Shareholder Return YORW (The York Water Company) ? Total Shareholder Return = ( ( Current Price - Purchase Price ) + Dividends) / Purchase Price ? Total Shareholder Return from a 24 month investment = ( ( $40.57 - $32.33) + $1.349 ) / $32.55 = 29.459% ? This investment out-performed the market as the Total Stockholder Return for American and European Utilities was 4.5% and 14.3% respectively last year. This performance is most likely attributable to overall market performance as most water utility companies including the companies in this report are generally in good positions. YORW seems to be doing exceptionally well. However, Jeffrey Hines, the former CEO that has been apart of the company since 1990 has just left this past March. The new CEO, Joseph Hand, can be a cause for concern if the new leadership of YORW does not work as efficiently. The York Water Company vs. Peers in Industry ? As mentioned earlier in the report, the most striking findings from this table are that The York Water Company is experiencing growth in almost all categories listed in the table. When compared to a company such as Middlesex Water Co. The York Water Company outperforms MSEX in a 5 year period in growth of earnings and sales/revenues. The CWT is a company much larger than YORW, thus their rates of growth for market capitalization, earnings, and sales/revenues over the past 5 years are larger as well. 5. 10-K ? Based on the 10-K filing and reading, there doesn’t seem to be anything which stands out to investors as worrisome. To summarize the 10-K, President Hand of YORW reported an increase in operating revenues of $3,141,000 to $51,578,000. This is 3 times the increase YORW had in 2018. Earnings per share increased by $0.07 to $1.11 as well as dividends per share by 4% compared to 2018. President Hand includes that this increase in revenues was partially offset by higher operating and maintenance expenses, one of the main risks of Utility companies as mentioned earlier in the report. Also, President Hand is planning to invest approximately $29.5 million in 2020 and $27.0 million in 2021 for spillway improvements, re-armoring of one of the dams, expansion of a wastewater treatment plant, and a system expansion amongst other infrastructural improvements. One risk investors should keep in mind is the operating revenue and net income values. If these numbers are dwindling or not maintaining the steady growth they are now, investors should keep in mind all the infrastructural changes YORW is planning to make, and what could happen if YORW doesn’t have the income to finance them. This could lead to some losses for YORW as the quality of water supply and wastewater systems is a necessity for a safe and efficient system, and without such a system, customers may lose faith in the company. B. Corporate Valuation – Introduction 1. We utilized the Discounted Free Cash Flow Model to analyze the future cash flows of YORW and calculate the intrinsic value of the company’s stock. 2. The Discounted Free Cash Flows were calculated for the years 2020 through 2025