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Is Microsoft a Buy?

By David Jagielski – Nov 2, 2019 at 8:05AM

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The trillion-dollar market cap company still offers investors a lot of value.

Microsoft (MSFT 1.92%) has been one of the top names in tech for decades, and with a market capitalization of over $1 trillion, it's one of the most highly valued companies today. Even amid rising competition from some big names in the industry like Apple and, the company has been able to not only keep growing its sales but to significantly expand its profits along the way as well.

Up 200% over the past five years, Microsoft has remained a strong investment. But let's take a closer look at where it is today and whether it's still, at a rather high earnings multiple, a good buy or not.

Another impressive earnings beat

Microsoft recently released its fiscal first-quarter earnings for 2020, and yet again, the stock surpassed expectations with earnings per share of $1.38 and revenues of $33.06 billion. However, beating expectations has been the norm for Microsoft, and that's why a strong performance is usually not enough for the stock to get a big boost. 

A boy playing a video game on a computer.

Image source: Getty Images.

The one negative for the company that likely kept its stock from soaring was that its guidance for Q2 was a little underwhelming. Microsoft is projecting revenue to come in as high as $35.95 billion next quarter, which is shy of the $36.02 billion that analysts are anticipating, but that amounts to a variance of less than 1%. Unfortunately, any blemish could be enough to keep the stock from gaining traction.

Diversification and recurring revenue are the company's greatest strengths

A growing trend we've seen in the world of tech is a move toward software as a service (SaaS), in which companies generate recurring revenue and simply push out their latest product updates via the cloud. Microsoft is a great example of how to do that well with the success of its Office 365 subscription service, which now has more than 200 million commercial monthly active users. Office is a staple at many companies, and without a viable competitor, it ensures that Microsoft will be able to continue enjoying stable, recurring revenue even without having to make significant changes to its existing software.

However, whether it's Office, gaming, or other recurring services, what makes Microsoft strong is its wide variety of revenue streams. The one exhibiting the strongest growth, Azure, the company's cloud computing platform, generated year-over-year sales growth of 59% this past quarter. While that's impressive, it's lower than the 64% expansion it generated in fiscal Q4 2019 and down from Q1 of last year when it sported a growth rate of 76%. 

Although the slowing growth rates may be cause for concern, the reality is that Microsoft will likely continue finding new avenues for growth. It did just that recently when it secured a contract worth $10 billion from the Department of Defense for the Joint Enterprise Defense Infrastructure (JEDI)  Cloud contract. The 10-year deal is an important one that will involve modernizing the Pentagon's technology, which will inject Microsoft with even more sales. 

Is Microsoft's valuation too rich?

There's no denying Microsoft is a solid company, and there are still a lot of ways the company can grow simply by monetizing more of its services and expanding existing ones. The big question, especially for value-oriented investors, is whether the stock is simply too expensive.

In total, revenue rose just 14% year over year this past quarter, and for a stock that trades at 26 times its earnings, an argument could be made that it is a bit rich for that level of growth. A price-to-book multiple of 10 also suggests that investors are paying a bit of a premium for the stock today. 

Microsoft is currently trading near its 52-week high, and it's definitely a bit on the expensive side. However, if you're going to pay a premium for a stock, it may as well be one like Microsoft that has a strong brand behind it, offers lots of great products and services, and incurs relatively lower risk versus other tech stocks. And with a dividend yield of around 1.5%, investors have a bit of an extra incentive for owning the stock.

While you won't be getting a bargain by buying shares of Microsoft today, it is a quality, long-term investment that can generate some solid returns for you over the years. 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. David Jagielski has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Apple, and Microsoft. The Motley Fool has the following options: short January 2020 $155 calls on Apple and long January 2020 $150 calls on Apple and recommends the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2021 $85 calls on Microsoft. The Motley Fool has a disclosure policy.

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