Microsoft Stock – Too High, Too Fast?

by Trefis Team
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After a 59% rise since the March 23 low of this year, at the current price of around $215 per share, we believe Microsoft’s stock (NASDAQ:MSFT) has only a moderate upside left. Microsoft’s stock has increased from $136 to $215 off the recent bottom, better than the S&P which increased by around 47%. The rise in stock price was helped by the Fed’s multi-billion dollar stimulus package announced on March 23rd which lifted market sentiments. The price further rose as Microsoft’s Q3 and FY 2020 (ended June) earnings beat market estimates. In Q3 and Q4 2020, due to the coronavirus the company saw higher demand in cloud usage and as customers had work from home orders. The company also displayed higher demand of Windows OEM, Surface, and Gaming which benefited from increased demand due to lockdown conditions. The company is currently in conversation with ByteDance to buy the U.S. operations of TikTok, the popular Chinese video application which has come under scrutiny from the U.S. government due to concerns of privacy and ties to the Chinese state.

The stock now stands 229% above the levels at which it was at the end of 2017 and it has surpassed the pre-Covid (February 2020) high of $189. We believe that the company’s stock has only a moderate upside left. Our dashboard ‘What Factors Drove 229% Change In Microsoft Stock Between 2017 And Now? has the underlying numbers.

Some of the stock price rise in the 2017-2020 period (FY ends in June) is justified by the 48% growth in revenues. Microsoft’s revenues increased from $97 billion in 2017 to $143 billion in 2020, mainly driven by growth in Cloud revenues. The company also saw a 74% increase in Net Income as net income margin improved from 26.4% in 2016 to 31% in 2020.

Stock price increased during this period as margins and revenue grew (and as 2018 margin decline was due to one time tax expense). The P/E multiple also rose from 20x in June 2016 to 37x currently. We believe that the market has been optimistic about Software companies in the current environment, which has led to its rise.

Effect of Coronavirus

The global spread of coronavirus has led to lockdown in various cities across the globe, which has affected industrial and economic activity. This is likely to adversely affect consumption and consumer spending. Notably, Microsoft’s stock is up by about 27% since January 31, after the World Health Organization (WHO) declared a global health emergency in light of the spread of coronavirus. However, during the same period, the S&P 500 index was up 2%. Despite the coronavirus pandemic the company saw a 13% growth in Total revenues for FY 2020. Intelligent Cloud led the revenue growth recorded at 24% y-o-y while the Personal computing and Productivity and Business Processes segments saw revenue increase by 9% y-o-y.

Following the Fed stimulus — which helped to set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value.

Thus, with high revenue growth over the years, better than expected FY 2020 revenue, despite the crisis, has helped Microsoft expand its P/E multiple to 37x currently. With investors’ focus shifting to 2021, the P/E multiple could rise on the expectations of continued revenue growth and profit margin improvement, leading to a rise in the stock price. As per Microsoft’s valuation by Trefis, MSFT’s fair price estimate comes to $226.

While MSFT stock is likely to see moderate upside in the near term, how has Google’s stock moved over the years?

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