Microsoft: Invest Now Or Miss Out?

Microsoft is a tech giant that has been dazzling investors with its growth and initiatives in artificial intelligence. The company has a strong presence in the cloud computing market with its Azure infrastructure services and is continuously expanding its offerings. While Microsoft stock has been on a bullish trend, the decision to invest depends on individual circumstances and risk appetite. Here is an overview of the pros and cons of investing in Microsoft stock as of 2021.

Pros:

- Microsoft has a strong moat in the industry and is continuously diversifying into new avenues, such as cloud computing, remote work apps, and video games.

- The company has shown impressive financial performance, with revenue rising 22% year over year to $45.3 billion and adjusted earnings growing 25% to $2.27 per share.

- Microsoft has a solid balance sheet with a cash position of nearly $130.6 billion, outperforming its competitors in the cloud market.

- The company has a stable and dependable reputation, absent from the US government's looming antitrust investigations into Big Tech peers.

- Microsoft's current CEO, Satya Nadella, has led the company's return to prominence and revenue diversification, with a focus on cloud computing.

Cons:

- Microsoft stock may be too high for new investors, with a price-to-earnings (P/E) ratio of 37, which has risen significantly since Satya Nadella became CEO in 2014.

- The company faces stiff competition in almost every industry it dabbles in, including Surface tablets, Bing search engine, and Azure cloud services.

- There is a risk that a competitor could develop breakthroughs in technology, such as quantum computing or artificial intelligence, where Microsoft should have been more aggressive.

Microsoft's cloud services

The company's cloud transformation has paid off, with Microsoft Cloud's revenue rising 36% year over year to $20.7 billion in the first quarter of 2021. This growth has been attributed to CEO Satya Nadella, who took over in 2014 and aggressively expanded the company's cloud services.

In addition to Azure, Microsoft's cloud services include:

• Office 365: A cloud-based version of Microsoft Office, which includes Word, Excel, and PowerPoint.
• Dynamics 365: Enterprise software that includes Dynamics 365 Finance.
• LinkedIn: The professional social networking platform acquired by Microsoft.
• OneDrive: Microsoft's personal cloud storage service, which offers 5 GB of free storage or more with a Microsoft 365 subscription.
• AI-powered services: Microsoft has been infusing AI into its cloud services, such as the Microsoft 365 Copilot, which uses AI to automate tasks and provide suggestions.

Microsoft's growth

Cloud Services

Enterprise Services

During the onset of the pandemic, Microsoft's enterprise services, such as Office 365 Commercial, Dynamics 365, and LinkedIn Marketing Solutions, experienced slowdowns due to business closures. However, as businesses reopened, these services rebounded and generated accelerating growth.

Artificial Intelligence (AI)

Microsoft has been heavily investing in AI and promoting its advances in this field. In January 2023, the company invested $10 billion in AI startup OpenAI, the creator of ChatGPT and Dall-E. Microsoft has been integrating OpenAI models into its software products, such as Bing, Edge, and Office 365. The company has also introduced AI-powered Copilot functionality to its cybersecurity offerings and GitHub service, and launched AI PCs with dedicated Copilot buttons.

Gaming

Microsoft completed its acquisition of video game publisher Activision Blizzard in October 2023, bringing popular game franchises such as "Call of Duty", "World of Warcraft", and "Candy Crush" under its umbrella. This acquisition faced regulatory delays and antitrust challenges but is expected to boost Microsoft's gaming division.

Financial Performance

Microsoft's revenue for the quarter ending March 31, 2024, was $61.858 billion, a 17% increase year-over-year. The company's annual revenue for 2023 was $211.915 billion, a 6.88% increase from 2022. Microsoft's cloud strength fuelled its third-quarter results, with a 23% year-over-year increase in Microsoft Cloud revenue. The company's operating income, net income, and diluted earnings per share also increased by 23%, 20%, and 20% respectively.

Stock Performance

Microsoft's stock has risen significantly under the leadership of CEO Satya Nadella, who took over in 2014. Since then, the stock has risen by nearly 800%, and as of July 2024, the company's market capitalization reached $2.5 trillion. Microsoft's stock price hit an all-time high after its impressive first-quarter report in October 2021, with revenue rising 22% year over year to $45.3 billion.

In summary, Microsoft's growth has been driven by its expansion into cloud services, enterprise services, AI, and gaming, resulting in impressive financial and stock performance. The company continues to innovate and invest in new technologies, positioning itself for further growth and profitability.

Microsoft's cash returns

Microsoft has been returning tens of billions of dollars to its investors. In fiscal 2021, the company spent over $39 billion on dividends and buybacks, which was about 70% of its free cash flow (FCF). In the first quarter of 2022, it spent another $10.9 billion, or 58% of its FCF, on both plans.

Microsoft's forward dividend yield of 0.8% is not a serious draw for income investors, but the company has reduced its share count by nearly 10% over the past seven years, offsetting dilution from its share-based compensation plans.

In the first quarter of fiscal 2022, Microsoft's revenue rose 22% year-over-year to $45.3 billion, beating analysts' estimates by $1.3 billion. Its adjusted earnings grew 25% to $2.27 per share, clearing expectations by $0.19.

The company's intelligent cloud division increased its revenue to $17 billion, a 31% gain year-over-year. Its productivity and processes division, which has turned Office into a cloud-based product through Microsoft 365, reported $15 billion in revenue, a 22% increase over the last 12 months.

Microsoft's cash position is just under $130.6 billion, which means it could repay its $53.3 billion in debt and still have cash left over to make investments. This position also allows Microsoft to return cash to shareholders in the form of dividends. In the first quarter of 2022, the company returned almost $10.9 billion to shareholders in dividends, a 14% increase from the year-ago quarter. The $2.48 annual payout yields about 0.8%.

Microsoft's moat

Brand Strength and Household Name

Microsoft's brand name is a significant part of its moat. The company has established itself as a household name in the technology sector, with products such as Windows and Office that have dominated the market for decades. This strong brand identity has led to high brand recognition and loyalty among consumers.

Network Effect and Switching Costs

The network effect also contributes to Microsoft's moat. Its products, such as Windows and Office, have high network effects, where the value of the product increases with the number of users. For example, Microsoft's operating systems and software suites have become industry standards, and switching to a different platform would be costly and time-consuming for many businesses and individuals.

Technological Superiority and Dominance

Microsoft has consistently demonstrated technological superiority and dominance in the market. With a long history of innovation since the 1980s, the company has maintained its leadership in software and high-tech devices. Its recent focus on artificial intelligence (AI) and the metaverse further showcases its ability to adapt and stay at the forefront of emerging technologies.

Research and Development (R&D) Investments

Microsoft has been investing heavily in R&D, spending over $10 billion annually since 2013, with $21 billion invested in 2021 alone. This commitment to innovation ensures that the company stays ahead of the competition and adapts to changing market demands.

Cloud Services and Azure

Microsoft's cloud services, including Azure, Office 365, Dynamics, and LinkedIn, have been a key driver of the company's growth. While Amazon Web Services dominates the cloud market, Microsoft is a close second and continues to gain market share. The company's investments in cloud infrastructure and hybrid environments position it well for the future of enterprise computing.

Strong Financial Position and Cash Reserves

Microsoft boasts one of the strongest balance sheets in the industry. With a large cash position of nearly $130 billion, the company has significant financial flexibility to invest in new technologies, acquire key businesses, and return value to shareholders through dividends and share buybacks.

In summary, Microsoft's moat is built on a combination of brand strength, network effects, technological superiority, R&D investments, cloud services, and a strong financial position. These factors contribute to the company's competitive advantage and protect its market share, making it a compelling investment opportunity for those following the philosophies of investors like Warren Buffett.

Microsoft's stock valuation

Microsoft's Stock Performance

Microsoft (MSFT) has a strong track record of stock performance. Its share price has risen by nearly 800% since Satya Nadella became CEO in 2014, with a surge of almost 55% in the last year alone. This growth has been driven by the expansion of its cloud services, including Azure, Office 365, Dynamics, and LinkedIn, collectively known as the "Microsoft Cloud." The company's intelligent cloud division's revenue increased by 31% year over year to $17 billion.

Market Capitalization and Valuation

Microsoft's market capitalization, as of July 2024, is approximately $3.4 trillion, with a share price of around $450. However, some analysts consider the stock to be overvalued. One source claims that the intrinsic value of one MSFT stock is $278.44, indicating a 39% overvaluation compared to its current market price. The price-to-earnings (P/E) ratio stands at 37, which is significantly higher than the 15 earnings multiple when Nadella became CEO. This suggests that the stock is not cheap, and the high valuation may make it challenging for Microsoft to replicate its past multi-bagger gains.

Financial Performance

Microsoft's financial performance has been impressive. For the first quarter of fiscal 2022, the company reported revenue of $45.3 billion, a 22% increase year over year, surpassing analysts' estimates. Adjusted earnings grew 25% to $2.27 per share, also clearing expectations. The company's cloud services continue to be a key driver of growth, with Microsoft Cloud's revenue rising 36% year over year to $20.7 billion.

Analyst Recommendations and Outlook

Despite the impressive performance, some analysts express caution due to the stock's valuation. The high market cap and valuation may pose challenges for future growth. However, others argue that Microsoft deserves a premium valuation due to its solid long-term investment prospects, benefiting from the secular expansion of the cloud services market. Wall Street analysts forecast the MSFT stock price to rise over the next 12 months, with an average one-year price target of $498.75 and a high forecast of $630.

In conclusion, while Microsoft's stock valuation is rich, the company's strong financial performance, cloud growth, and positive analyst outlook suggest it remains a compelling investment opportunity. However, the potential challenges of its size and valuation are essential factors to consider.

Frequently asked questions