Is There More Upside For MSFT Stock?

Microsoft (NASDAQ:MSFT) delivered a strong Q4 performance, surpassing consensus estimates for earnings, sales, and its future outlook. This positive news has sent the stock up 8% in pre-market trading, extending its impressive rally of over 50% since its April low of around $350. Despite this significant climb, we believe there’s still considerable upside potential.

While Microsoft’s current valuation is high, we see minimal cause for concern, making it an attractive investment. Our optimistic view stems from a comprehensive analysis comparing MSFT’s current valuation to its recent operating performance and its historical and current financial health. We’ve assessed Microsoft across key parameters: Growth, Profitability, Financial Stability, and Downturn Resilience. This analysis reveals Microsoft’s exceptionally strong operating performance and financial condition.

That said, if you seek upside with lower volatility than individual stocks, the Trefis High Quality portfolio presents an alternative – having outperformed the S&P 500 and generated returns exceeding 91% since its inception. Separately, see – META Stock To $1,500?

Solid Revenue Growth

Microsoft has demonstrated notable revenue growth in recent years, outperforming the S&P 500. Over the last three years, its top line has grown at an average rate of 12.5%, compared to 5.3% for the S&P 500. In the most recent twelve-month period, revenues increased by 14.9% from $245 billion to $282 billion, while the S&P 500 saw 4.4% growth. Quarterly revenues in the most recent period grew 18% to $76.4 billion from $65 billion a year ago, against a 4.5% improvement for the S&P 500. This consistent, strong revenue expansion supports the company’s robust market position.

Profitability On The Rise

Microsoft exhibits exceptionally high profit margins, considerably exceeding most companies in the Trefis coverage universe. Its operating income over the last four quarters was $129 billion, translating to a substantial operating margin of 45.6%, in contrast to 18.3% for the S&P 500. The company’s operating cash flow (OCF) for the same period was $136 billion, indicating a very high OCF margin of 48.3% compared to 19.8% for the S&P 500. Furthermore, Microsoft’s net income of $102 billion over the last four quarters yielded a considerable net income margin of 36.1%, significantly higher than the S&P 500’s 11.8%. These strong profitability metrics underscore Microsoft’s efficient operations and effective cost management.

Robust Financial Strength

Microsoft’s balance sheet is characterized by very strong financial stability. As of the most recent quarter, its debt stood at $61 billion, with a market capitalization of close to $4 trillion. This translates to a very strong debt-to-equity ratio of 1.5%, which is substantially lower than the S&P 500’s 23.4%.

The company also maintains a healthy cash position, with cash (including cash equivalents) making up $95 billion of its $619 billion in total assets, resulting in a strong cash-to-assets ratio of 15.3% compared to 6.7% for the S&P 500. These figures highlight Microsoft’s robust financial health and its ability to manage its liabilities effectively.

Good Downturn Resilience

Microsoft stock has generally shown slightly better resilience than the broader markets during recent economic downturns. During the Inflation Shock of 2022, MSFT fell 37.6% but fully recovered by June 15, 2023. In the Covid Pandemic of 2020, MSFT saw a 28.2% decline from its peak, recovering fully by June 9, 2020, outperforming the S&P 500’s 33.9% drop. Look at Buy or Sell MSFT stock for more details.

But Valuation Is High

Overall, Microsoft demonstrates very strong performance across growth, profitability, and financial stability, with its downturn resilience being neutral. This comprehensive analysis points to an overall very strong outlook for MSFT stock.

Microsoft’s stock currently commands a premium valuation when compared to the broader market, as well as some of its peers, reflected in its key multiples. Its price-to-sales (P/S) ratio stands at 14.6, significantly higher than the S&P 500’s 3.1. Similarly, its price-to-earnings (P/E) ratio of 40.7 substantially exceeds the benchmark’s 22.8. This is higher than its peers, with META stock trading less than 30 times and AMZN stock trading at 39 times trailing earnings. This elevated valuation suggests market confidence in Microsoft’s future performance and its strong competitive position.

The Verdict

Microsoft’s recent performance strongly suggests that a premium valuation is well-deserved. The accelerating growth in Azure revenues, coupled with improving profitability and a robust outlook, points towards a sustained upward revision in its valuation multiple. While the stock currently trades at over 40 times trailing earnings, it has historically commanded premium valuations; for example, its average price-to-earnings ratio over the last four years is 35 times. Consequently, we believe there is still further upside potential for MSFT stock, despite its recent surge.

Of course, this optimistic view carries inherent risks. Investors might become hesitant to pay an even higher premium, particularly given the substantial capital expenditure Microsoft is directing towards AI initiatives. It is crucial for investors to thoroughly consider all associated risks before making any investment decisions. However, for those with a 3−5 year investment horizon, MSFT stock, even at its current levels, could offer significant upside potential. Related – MSFT Stock To $1,000?

Now, there always remains a meaningful risk when investing in a single stock, or just a handful of stocks. Consider the 30-stock Trefis High Quality (HQ) Portfolio, which has a track record of comfortably outperforming the S&P 500 over the last 4-year period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride, as evident in HQ Portfolio performance metrics.