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Is Microsoft Stock a Buy?

By Herve Blandin - Updated Jul 27, 2020 at 12:39PM

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The tech giant posted strong fiscal fourth-quarter results and it is poised to grow over the long term. But its stock remains close to its all-time highs.

Last week, Microsoft (MSFT -1.39%) posted better-than-expected fiscal fourth-quarter results, despite coronavirus-induced challenges. In addition, the tech giant is poised to keep growing over the long term thanks to its huge investments and successful transition to cloud computing. But at only 6% below its all-time highs, and up 43% over the last 12 months, is Microsoft stock a buy?

Strong results and long-term growth

The coronavirus had a negative impact on some of Microsoft's businesses during the last quarter. For instance, given the weak job market, the social network LinkedIn (acquired in 2016 for $26.2 billion) grew its revenue by only 11% year over year at constant currency, down from 28% a year ago. Also, revenue from search advertising dropped 17% year over year because of lower advertising rates.

Widescreen financial chart with uptrend line arrow graph and world map on green color background.

Image source: Getty Images.

However, other businesses benefited from shelter-in-place orders. For example, with year-over-year revenue growth of 68% at constant currency, Xbox console and services represented Microsoft's highest growth activity during the last quarter.

Beyond these short-term quarterly results, Microsoft's fiscal year 2020 was impressive. The company increased its revenue to $143 billion, up 13.6% year over year, with strong growth across its three segments.

Microsoft Segment Products and Services Revenue Fiscal 2020 Revenue Growth Fiscal 2020 (YOY)
Productivity and Business Processes

Office 365, Microsoft Teams, Skype, LinkedIn, Dynamics business solutions, and others.

$46.4 billion 12.7%
Intelligent Cloud SQL Server, Windows Server, GitHub, Azure, enterprise services, and others. $48.4 billion 24.1%
More Personal Computing Windows, devices (surface tablets and others), gaming, and search. $48.2 billion 5.6%

Data Source: Microsoft. YOY = year over year.

Unsurprisingly, cloud businesses boosted the company's results. CEO Satya Nadella highlighted commercial cloud revenue on the company's most recent earnings call, noting that Microsoft Office 365 Commercial, Microsoft Azure, and other cloud businesses surpassed $50 billion in fiscal 2020, up from $38.1 billion the prior year.

Based on the midpoint of management's revenue guidance, year-over-year revenue growth should decelerate to 7.7% during the next quarter. But given Microsoft's scale, that revenue growth remains impressive as it corresponds to more than $2.5 billion of extra revenue in just three months. And beyond these short-term forecasts, the company is poised to keep growing over the long term. 

A study from Grand View Research anticipates revenue from the cloud market will grow at a compound annual rate of 14.6% by 2027, and Microsoft should at least match that growth. According to Canalys, Microsoft Azure increased its market share to 17% in the cloud infrastructure market in Q1, up from 15% a year ago. And during the last quarter, revenue from Azure increased by 50% at constant currency.

Also, with $19.3 billion in research and development expenses during the last fiscal year, Microsoft deployed significant and growing resources to remain competitive that only a few tech stocks can match. Granted, these investments are spread across the company's various businesses, but Microsoft realizes significant synergies with its software solutions that leverage its cloud infrastructure platform Azure.

MSFT Research and Development Expense (Annual) Chart

MSFT Research and Development Expense (Annual) data by YCharts

What about the stock?

With its growing scale, Microsoft increased its fiscal 2020 operating income to $53 billion, up from $43 billion a year ago. And with $73.2 billion of cash and short-term investments in excess of its total debt, the tech giant seems immune from financial difficulties over the long term. That safety net also provides the company with some dry powder to acquire businesses it can scale to grow its empire. For instance, it acquired Affirmed Networks this year to expand its footprint into the growing 5G market.

As a result, the market values the company at a high trailing-12-month price-to-earnings (P/E) ratio of 36. And when taking into account analysts' forecasted fiscal 2021 earnings, that multiple drops to 32, which remains elevated.

Also, Microsoft stock's multiple-to-sales ratio has been expanding over the last few years despite flattish revenue growth. That multiple expansion is related to the company's increasing operating margins as it is scaled. But sustaining double-digit revenue growth over the long term with such scale will become challenging, which should limit the potential to improve operating margins that have already reached high levels.

MSFT EV to Revenues Chart

MSFT EV to Revenues data by YCharts

Thus, despite Microsoft's phenomenal operational performance over the last several years, prudent investors should stay on the sidelines. Given its rich valuation and likely decelerating revenue growth because of its massive scale, Microsoft stock's upside potential seems limited, even if the company keeps delivering strong results. 

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.

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