Bill Gates and Paul Allen laid the foundations of Microsoft (MSFT) in 1975. Since then, the company has continued to dominate the software market. However, after rigorous success in one segment, the company also sells tangible products in the market. It now operates in software, hardware, software suites, operating systems, cloud computing, devices, and apps. It’s safe to say that the world would be fundamentally different without Microsoft.
I am neutral on Microsoft as it has a strong competitive position, a promising long-term growth runway, Wall Street analysts are overwhelmingly bullish on the stock, and the average price target implies a good amount of upside potential over the next year.
On the other hand, the valuation multiples are elevated relative to the company’s historical averages, making the total return outlook somewhat uncertain.
Strengths
In the global technology software market, Microsoft is an undisputed leader. It is the world’s largest developer for the Windows operating system because of which its number of users is increasing at a rapid pace. Since the company has been operating in the software technology space effectively for a long time, it has managed to control the largest share of the market.
According to Investor’s Business Daily, the company has consistently grown its revenue, and by the end of 2022, it could have a $2 trillion valuation. Moreover, according to Interbrand, Microsoft is the third best brand globally.
Recent Results
In the quarter that ended September 30, Microsoft’s revenue stood at $45.3 billion, a 22% increase from the last quarter. Its operating income was at $20.2 billion, and it had risen by 27%, while its net income was $20.5 billion GAAP and non-GAAP income was $17.2 billion. These numbers had risen by 48% and 24%, respectively.
Microsoft also reported that its revenue from cloud services (Microsoft Azure is one of them) and commercial products had grown by 18%, driven mainly by the 23% revenue growth of Office 365 Commercial.
Valuation Metrics
MSFT stock looks overpriced at the moment. Its forward enterprise-value-to-EBITDA ratio is elevated relative to its history at 22.8 times compared to its historical average of 17.5 times.
Furthermore, its forward price-to-normalized-earnings ratio is 33.1 times compared to its historical average of 27.7 times. Analysts expect the company to see revenue, EBITDA, and normalized EPS growth in 2022 of ~14%, ~16%, and ~14%, respectively.
Wall Street’s Take
Turning to Wall Street, MSFT earns a Strong Buy consensus rating based on 24 Buy ratings and one Hold Rating assigned in the past three months. Additionally, the average Microsoft price target of $373.91 puts the upside potential at 20.5%.
Summary and Conclusions
Microsoft is an extremely strong company and is, in fact, one of the most valuable companies in the world. It attracts some of the top talents, which fuels its innovation and ability to build powerful intellectual property-based competitive advantages.
Furthermore, Wall Street analysts are overwhelmingly bullish on the stock, and the average price target indicates that it could see significant upside over the next year.
That said, the stock’s valuation appears a bit stretched relative to its historical averages, and while growth is expected to be strong over the next year or two, investors might want to wait for a more meaningful pullback in the share price before adding.
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