Microsoft (MSFT 1.82%) stock has generated a total return of more than 1,000% over the past 10 years. Most of those gains occurred after Satya Nadella took the helm as the tech giant's third CEO in 2014.
Under Nadella, Microsoft transformed its fledgling cloud business into its core growth engine. It expanded Office and Dynamics as cloud-based services and turned Azure into the world's second-largest cloud infrastructure platform after Amazon Web Services (AWS). It launched new Surface devices and Xbox consoles and gobbled up other companies to expand its gaming business.
Image source: Microsoft.
Between fiscal 2014 (which ended in June of the calendar year) and fiscal 2021, Microsoft's annual revenue grew at a compound annual growth rate (CAGR) of 10%, as its earnings per share (EPS) rose at a CAGR of 17%. As a percentage of its total revenue, Microsoft's commercial cloud revenue increased from just 5% in fiscal 2014 to 41% in fiscal 2021.
That dramatic transformation breathed fresh life into Microsoft's stock, prevented it from becoming an also-ran of the tech sector, and turned it into a $2 trillion company last year. But can Microsoft maintain that momentum over the next decade? Let's review the bear and bull cases to decide.
Why the bears think Microsoft's stock will stagnate
The bears believe Microsoft's business is still exposed to macroeconomic headwinds. It's reportedly been increasing its salaries and stock-based compensation for certain departments to counter inflation but also been slowing down its hiring for its Windows, Office, and Teams groups.
Those adjustments aren't surprising but indicate Microsoft might be bracing for slower growth and other macroeconomic challenges this year. The company's sales of Xbox Series consoles and Surface devices could also be limited by chip shortages and supply chain constraints.
Microsoft's planned takeover of Activision Blizzard (ATVI) for $68.7 billion also raises red flags. Activision is one of the world's largest video game publishers, but it's been struggling with the slowing growth of its aging franchises and a sexual harassment scandal. The deal still needs to be approved by antitrust regulators, and Microsoft would need to pay a $3 billion fee if the deal falls apart.
Buying Activision might strengthen Microsoft's first-party publishing business and add more games to its Xbox Game Pass and Xbox Cloud Gaming platforms. However, it could also be biting off more than it can chew.
Microsoft also seems to be falling behind Meta Platforms and Apple in the race to launch consumer-facing augmented reality (AR) devices. Microsoft established an early mover's advantage in that market with the developer version of the HoloLens in 2016 but still hasn't launched a cheaper consumer-facing device yet. If the AR market suddenly takes off, Microsoft could be left behind another tech curve -- just as it initially missed the transition toward smartphones under Steve Ballmer.
Why the bulls believe Microsoft's brightest days are ahead
Wall Street remains overwhelmingly bullish on Microsoft. Analysts expect its revenue and adjusted earnings per share (EPS) to rise 19% and 16%, respectively, in fiscal 2022. In fiscal 2023, they expect its revenue to increase 14% as its adjusted EPS grows another 16%. Those are rock-solid growth rates for a stock that trades at just 23 times forward earnings.
The bulls remain confident in Microsoft's growth prospects because its cloud business is still firing on all cylinders. Azure, the most closely watched component of that segment, has consistently generated 40%-50% year-over-year revenue growth over the past year. It's also consistently grown its market share against AWS as it attracts more customers -- especially brick-and-mortar businesses that don't want to work with Amazon. Its entire cloud business, which also includes Office and Dynamics, has delivered more than 30% revenue growth over the past year.
Microsoft also doesn't seem too concerned about the macro headwinds. During last quarter's conference call, CFO Amy Hood said it expected to "close FY '22, even in a more complex macro environment, with the same consistency we have delivered throughout the year, with strong revenue growth, share gains, and improved operating margins." Hood also predicted Microsoft would continue to deliver "healthy double-digit revenue and operating income growth" in fiscal 2023. Satya Nadella also said that even in a tough macro environment, most businesses weren't "looking to their IT budgets or digital transformation projects as the place for cuts."
Lastly, Microsoft has plenty of cash to ride out the storm. It ended last quarter with $104.7 billion in cash, cash equivalents, and short-term investments and generated $63.7 billion in free cash flow (FCF) over the past 12 months. It spent 46% of that total on buybacks and 28% on dividends -- and will likely keep returning most of its FCF to its investors.
The strengths outweigh the weaknesses
Microsoft might not be completely immune to macro headwinds, but it's bounced back from plenty of economic downturns before. Its gaming and AR strategies are a bit messy but can easily offset any mistakes in those smaller divisions with the continued growth of its cloud-based services.
Microsoft's stock got a bit overheated last year, but it now looks a lot more attractively valued. Long-term investors should consider this a great opportunity to buy one of the tech sector's evergreen stocks.
