Microsoft's Sheer Size Limits Upside Potential
At this point, no investor will get rich off Microsoft (NASDAQ: MSFT) stock — at least, not quickly. With a market capitalization of $1.82 billion, the Redmond, Washington-based giant is too large and mature to post attractive multi-year returns.
Wall Street's Contradictory Outlook on Microsoft's Earnings
Wall Street views on MSFT highlight a bit of a contradiction. The average price target on the stock sits at $297, suggesting a 23% upside (plus another 1%-plus in dividends). Yet the consensus outlook for earnings per share in fiscal 2023 (ending June) suggests growth of less than 4% year-over-year, a notable deceleration from the 16% increase posted in fiscal 2022.
In other words, analysts believe MSFT should trade at about 31x earnings — even though those earnings are barely expected to grow. (In fact, a chunk of what growth Microsoft is expected to drive comes from share repurchases rather than increased profits from the operating business.)
It seems strange to be so bullish on the company ahead of such a challenging year. And, indeed, it’s likely to be a challenging year: Microsoft management admitted as much on the fiscal first quarter conference call back in late October.
Microsoft's Near-Term Challenges
The company is simply facing a series of challenges. The strong dollar is providing a headwind: currency took five total percentage points off the revenue growth rate in the most recent quarter and cut nine points off the increase in operating profit.
Microsoft benefited from the pandemic-driven boom in sales of personal computers; that tailwind is reversing, with Windows revenue from PC sales down 15% year-over-year in fiscal Q1. And in the enterprise market, customers are tightening their belts, providing another potential brake on overall growth.
Wall Street’s caution toward FY23 earnings, at least, seems logical. To some investors, its optimism toward Microsoft stock might not make nearly as much sense.
The Strong Long-Term Case for Microsoft
But the Street’s outlook makes sense— perhaps even highlights the opportunity here. FY23 will be a challenging year for Microsoft, particularly in the context of its impressive turnaround over the past decade. What’s important, however, is that it will be a challenge in the external environment, not because of any failure in the business, competitive problems, or other factors.
Whatever the bottom-line growth rate this year, the business is in fine shape. In the cloud space, Azure continues to chase down Amazon.com (NASDAQ: AMZN) in the bid for top market share, and Microsoft seems to have distanced itself from the likes of Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) and Oracle (NYSE: ORCL).
Windows and Office still have essentially no competition. Even Bing appears to be taking market share, though Google still dominates the search market.
Meanwhile, the challenges in the external environment are going to come to an end. The dollar will stabilize. PC sales likely return to their admittedly modest long-term growth rate. How the macro environment shakes out is anyone’s guess, but over time it will even out.
Microsoft's Attractive Valuation and Dividend Yield
The point is that the stock market — and yes, most stock analysts — are forward-looking. For Microsoft, it’s not only about what the company is doing now but what it’s likely to do over the next several years.
From that perspective, Microsoft stock looks attractive at current levels. The stock is trading at about 24x earnings, which isn’t particularly cheap. However, it’s worth noting that those earnings are expected to grow over the long term, and the company has a strong track record of delivering solid earnings growth.
In addition to its attractive valuation, Microsoft has a solid dividend yield. The company has been steadily increasing its dividend in recent years and currently sports a yield of around 1.3%. That’s not earth-shattering, but it’s a nice bonus for long-term investors.
Microsoft's Strong Balance Sheet and Diversified Business Model
Another factor in favor of Microsoft is its strong balance sheet. The company has a net cash position of about $134 billion, which gives it financial flexibility. It can use this cash to make strategic acquisitions, buy back stock, or hold onto it for a rainy day.
Finally, it’s worth noting that Microsoft is a diversified business. The company generates significant revenue from its cloud, Windows, and Office businesses, but it also has several smaller divisions contributing to its overall performance. This diversification helps mitigate risk and makes the company less vulnerable to the ups and downs of any particular market.
The Bottom Line on Microsoft Stock
Microsoft looks like a solid pick for long-term investors. The stock may not offer the same upside potential as more minor, more growth-oriented companies but carries less risk. With a strong balance sheet, diversified business model, and attractive valuation and dividend yield, MSFT is well-positioned to deliver consistent returns over the long haul.
