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Microsoft is Making Money, but is it Overvalued?

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·3 min read
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Microsoft (MSFT) is a computer software and hardware company that serves both business and consumer clients. Its products include cloud services, operating systems, enterprise software, software development tools, computer hardware, and gaming programs and hardware.

The main value for MSFT comes from its vast, highly technical, and economically valuable intellectual property portfolio as well as the significant switching costs that its business clients face once they are using its systems. The company enjoys particularly strong positions in its operating system, office business units, and cloud computing business segments and is also seeing strong growth across most of its business units. Its Azure cloud platform is seeing the most robust growth, as its revenue was up 50% year-over-year in their most recent quarterly results.

In its most recent quarter, MSFT announced astonishingly strong 39.3% year-over-year earnings-per-share growth, reflecting the strong demand for its competitively positioned products.

Given its strong brain trust from the top-tier talent it attracts, MSFT should continue to enjoy a strong competitive position for years to come. At the same time, it is unlikely that the company will grow earnings at the same clip as it has in its most recent quarter. MSFT is also enhancing its earnings-per-share growth by repurchasing shares at a steady rate, and has been growing its dividend-per-share at a fast pace every year for the past 19 years. (See Microsoft stock charts on TipRanks)

Valuation Metrics

Despite the company’s remarkable momentum and long-term potential, its valuation appears rather rich. Its forward price to earnings ratio is 34.7x compared to its 5-year average of 26.1x. Furthermore, their enterprise value to EBITDA ratio is 23.1x compared to its 5-year average of 16x.

As a result, while earnings-per-share will likely continue to grow steadily, likely multiple compression back towards historical averages will eat into total returns. Additionally, the dividend yield is currently a paltry 0.8%, so the dividend will not contribute much towards total returns.

Wall Street’s Take

From Wall Street analysts, MSFT earns a Strong Buy analyst consensus based on 27 Buy ratings in the past 3 months. Additionally, the average Microsoft price target of $297.96 puts the upside potential at 6.44%.

Summary and Conclusions

MSFT is riding significant momentum from its rapidly growing Azure cloud business, while its other business segments continue to generate strong growth as well. Additionally, share buybacks and dividend growth are bolstering shareholder returns and combine with MSFT’s strong competitive advantages, growth, and unanimous Wall Street analyst bullishness to make it appear to be an attractive investment.

That said, based on historical valuation multiples, the stock looks expensive right now and the dividend yield is too low to make a significant contribution to total returns. Furthermore, growth on a per-share basis is highly unlikely to keep up with its most recent quarterly pace. Last but not least, MSFT’s cloud business faces strong competition from fellow tech giants such as Amazon (AMZN), Oracle (ORCL), Google (GOOG), and IBM (IBM).

MSFT certainly has a lot going for it and may be worth an investment right now, but investors should not expect future returns to repeat the stock’s past performance, given its rich valuation.

Disclosure: On the date of publication, Samuel Smith had no position in any of the companies discussed in this article.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.