Microsoft 1999 — Great Business, Terrible Investment

“Microsoft sit­ting at such a low PE was crazy” - some guy on red­dit.

From time to time dur­ing the week, I read some of the invest­ing forums on Red­dit, and one of the recur­ring ideas I see, sur­pris­ing­ly enough, par­tic­u­lar­ly on the val­ue invest­ing sub­red­dit, is that peo­ple are stu­pid and don’t under­stand val­ue invest­ing if they’re ignor­ing the MAG 7 stocks.

For any­one that’s new to invest­ing or the Amer­i­can mar­ket, those are the com­pa­nies that are cur­rent­ly pub­licly list­ed and at the cen­ter of the AI boom: Apple, Microsoft, Google, Ama­zon, NVIDIA, Meta, and Tes­la.

They’ve had incred­i­ble suc­cess in terms of their stock price in the last few years, dri­ven pri­mar­i­ly by all of the expec­ta­tions that AI is going to take over every­thing and they will be some­where in the mid­dle of it.

And while I have high hopes for AI and do believe there’s a fair­ly high chance that it will con­tin­ue to devel­op and will be an incred­i­ble chap­ter in human his­to­ry, I also remem­ber what hap­pened in 1999.

I was actu­al­ly work­ing at Microsoft in 1999.

We were on top of the world. Bill Gates was still CEO, most peo­ple were access­ing the inter­net on our tech, Win­dows 98 Sec­ond Edi­tion was… okay, so that sucked. But Win­dows 2000 was just around the cor­ner… we were mak­ing seri­ous cash.

On the last trad­ing day of 1999, Microsoft closed at $35.75 a share.

At the time, they were the most valu­able com­pa­ny in the world.

Win­dows ran on almost every PC on the plan­et.

Microsoft Office was print­ing mon­ey.

The inter­net was being built on Win­dows servers.

If you told an investor in Decem­ber 1999 that Microsoft would dom­i­nate com­put­ing for the next two decades, most of them would have agreed.

Sure, there was some com­pe­ti­tion from Sun Microsys­tems and Ora­cle and IBM, but Microsoft was in a very strong posi­tion.

And if you’d bought 1,000 shares of Microsoft that day for $35,750, you would have wait­ed until 2016 to break even on that price, 17 years to get back to zero.

In those 17 years, Microsoft AS A BUSINESS did­n’t stag­nate.

They did noth­ing wrong.

They quadru­pled rev­enue from rough­ly $23 bil­lion in fis­cal year 2000 to near­ly $87 bil­lion by fis­cal year 2014.

They paid out tens of bil­lions of dol­lars in div­i­dends.

They were prof­itable every sin­gle quar­ter for almost the entire peri­od.

By any busi­ness mea­sure, they were one of the great cor­po­rate suc­cess sto­ries of the mod­ern era.

But the stock did noth­ing.

Sure, you would have col­lect­ed div­i­dends, and with those rein­vest­ed, you would have done a lit­tle bit bet­ter than noth­ing.

But over 17 years, you would have made a low sin­gle-dig­it return by buy­ing shares in the world’s most suc­cess­ful soft­ware busi­ness, while the broad­er mar­ket dou­bled and tripled around you.

Your cap­i­tal did noth­ing.

Why?

This is the bit most retail investors nev­er learn until it’s too late.

In 1999, Microsoft­’s price-to-earn­ings ratio was 75.

The PE ratio is the sim­plest val­u­a­tion tool there is.

You take the share price and divide it by the com­pa­ny’s earn­ings per share.

That num­ber tells you how many years of cur­rent earn­ings you’re pay­ing for in advance.

A PE of 15 means you’re pay­ing about 15 years of cur­rent prof­its to own a share.

A PE of 75 means you’re pay­ing 75 years.

The long-run aver­age PE for the S&P 500 is around 15 to 18.

Microsoft was trad­ing at four times that.

What does a 75 PE actu­al­ly mean for an investor?

It means you’re bet­ting that prof­its will grow enor­mous­ly fast for a very long time just to bring the mul­ti­ple back to some­thing nor­mal.

And that’s exact­ly what hap­pened.

Prof­its grew, div­i­dends were paid, the busi­ness was excel­lent.

But the mul­ti­ple com­pressed from 75 in 1999 down to around 12 by the ear­ly 2010s.

Let’s think about it in terms of the cof­fee shop anal­o­gy that Tony likes to use.

Imag­ine there’s a great cafe in your sub­urb that is absolute­ly killing it.

Lines around the cor­ner every week­end and every week­day.

Rave reviews for their cof­fee, their banana bread is out of sight, their muffins are boun­cy, the staff have all stud­ied Will Guidara’s “Unrea­son­able Hos­pi­tal­i­ty” cov­er-to-cov­er.

Peo­ple trav­el from around the world just for a sip of their sin­gle ori­gin cold brew.

It’s doing so well that it’s mak­ing a mil­lion dol­lars prof­it a year.

I don’t know if there are any cafes in the world that make that kind of prof­it, but just go with me here.

And let’s say you’re offered a chance to buy the busi­ness and the going price that the own­ers are ask­ing for is $75 mil­lion.

Now you’d have to ask your­self, what are the chances that I’m going to get that mon­ey back?

Sure, it’s a great cafe today, and it will prob­a­bly be a great cafe tomor­row, but will we be able to hold that rep­u­ta­tion and that posi­tion for 75 years in order for me to just get my mon­ey back, let alone make a prof­it on it.

Now let’s look at the Mag­nif­i­cent Sev­en in 2026.

Apple has a PE around 37, Microsoft 25, Google 28, Meta 18, Ama­zon 30, Nvidia 45, Tes­la 355!!!!

Tes­la is in a cat­e­go­ry of its own. At 355, Tes­la buy­ers today are pay­ing near­ly five times what Microsoft buy­ers paid in 1999 — and we already know how that one end­ed.

Even the oth­er six are all well above the his­tor­i­cal mar­ket aver­age.

The bull­ish case for each one rests on the same bet that Microsoft buy­ers made in 1999.

The com­pa­ny will keep grow­ing fast enough for long enough to jus­ti­fy the price you’re pay­ing today.

I’m not say­ing that any of these stocks will go side­ways for 17 years.

They might dou­ble from here, they might do bet­ter than that, or they might not.

The point is that the prin­ci­ple that destroyed Microsoft buy­ers for near­ly two decades is exact­ly the same one oper­at­ing on Mag 7 buy­ers today.

If you pay a pre­mi­um price for pre­mi­um growth you need that growth to keep show­ing up year after year, decade after decade, and the mul­ti­ple still has to hold.

Cis­co was the king of the inter­net build-out in 1999.

Their stock peaked at $80 in March 2000.

It did­n’t see that price again for more than two decades.

Intel was untouch­able.

Their 2000 peak was around $75.

They’ve spent most of the past 25 years well below it.

War­ren Buf­fett has writ­ten about the Nifty Fifty of the ear­ly 1970s, the blue-chip MAG 7 equiv­a­lents of their day, that ate a decade for buy­ers who paid the going rate.

Every era has its obvi­ous win­ners.

A few keep win­ning.

Almost none of them keep win­ning at the price the crowd is will­ing to pay.

And you only know which ones are going to win in hind­sight.

The QAV process that Tony devel­oped does­n’t ask, is this a great busi­ness.

It asks, is this a great busi­ness at a sen­si­ble price?

Those are dif­fer­ent ques­tions.

The first one would have put you into Microsoft in 1999.

The sec­ond would have kept you out.

A high QAV score requires both qual­i­ty and val­ue.

The check­list com­bines a qual­i­ty screen, good return on equi­ty, clean bal­ance sheet, real cash flow, a sound busi­ness mod­el, with a val­ue screen, a sen­si­ble price to oper­at­ing cash flow ratio, mar­gin of safe­ty against intrin­sic val­ue.

Stocks at a PE of 75 don’t get onto the buy list.

Stocks at a PE of 40 usu­al­ly don’t either.

The rules force you to ask what you’re actu­al­ly pay­ing, not just whether the com­pa­ny is famous.

A few months ago I wrote a piece called “Invest in MASS, not GAS”.

QAV invests in com­pa­nies with real mass, i.e. qual­i­ty busi­ness­es gen­er­at­ing real cash flow at rea­son­able prices, and avoids the gas giants whose stock prices are built almost entire­ly on pre­dic­tions of future dom­i­nance.

Microsoft in 1999 was the largest, bright­est, most suc­cess­ful gas cloud in the his­to­ry of cap­i­tal mar­kets.

The mass was real.

The busi­ness kept com­pound­ing, but the price you paid for it was almost entire­ly gas.

Keep in mind that the most vocal advo­cates for buy­ing the Mag 7 are peo­ple that have already invest­ed in them and there­fore have a vest­ed inter­est in their con­tin­ued price appre­ci­a­tion.

Maybe all of those busi­ness­es will con­tin­ue to boom for 10 more years.

Maybe only some of them will.

Maybe none of them will.

Nobody real­ly knows.

What I do know is I’m not going to wait 75 years for my cafe to break even.

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QAV Myth Killers is a week­ly col­umn in the QAV newslet­ter, tak­ing apart a piece of
invest­ing con­ven­tion­al wis­dom. Read the series, or
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