What happened
Shares of Microsoft (MSFT 0.60%) inched 2.4% higher on Friday, through 11:25 a.m. ET, despite not one, not two, but three separate analysts deciding to lower their price targets on the tech giant ahead of its earnings report due out Tuesday.
Tic-tac-toe, three in a row: Cowen & Co., Evercore ISI, and Citigroup all lowered their price targets on Microsoft stock, as ratings watcher The Fly reports today. Granted, all three bankers continue to recommend buying Microsoft stock ahead of the earnings report (which is probably why the stock is rising today).
But here's the really curious part: Each of these bankers set Microsoft's new target price at $280 on the nose.
NASDAQ: MSFT
Key Data Points
So what
What makes $280 the magic number for Microsoft? Why do all three of these analysts believe Microsoft shares will gain exactly 18% over the next 12 months?
Their reasons differ. Cowen, for example, thinks that growth in Microsoft's Azure cloud computing division slowed in fiscal Q2 -- but that the division still grew 33% or even 34%, as StreetInsider reports. Also, Cowen thinks other analysts may be exaggerating the risks to Microsoft Office sales.
Microsoft's announced layoffs of 10,000 employees is a separate issue. Cowen figures the severance costs from this restructuring will subtract about $0.10 per share from Microsoft's earnings this year.
Evercore, on the other hand, sees the layoffs as proof that Microsoft can "dynamically adjust" its input costs "to preserve EPS and free cash flow," notes The Fly. And if Microsoft can cut costs to preserve profits in the face of a recession, that's a reason why the stock could be worth more than it currently costs.
And as for Citi, well, this megabank agrees that an IT recession has arrived, and that this is likely to cut into revenue growth at both Azure and Office. On the other hand, Citi thinks Microsoft's problems won't be any worse than what its tech industry peers face. And overall, the megabanker just can't ignore the fact that Microsoft's valuation "is at multiyear lows versus the S&P." So even if Citi is cutting its price target, it's only cutting its price target by $2, from $282 to $280 a share.
Now what
But how exactly does Microsoft stock compare to the valuation of the S&P? Well, currently, the S&P 500 is trading for 20.5 times current year earnings, while Microsoft stock costs more than 25 times earnings. That's actually the opposite of a discount.
Does Microsoft deserve to trade at such a high premium to the S&P 500, though?
That Microsoft is a company of above-average quality, I think there can be no debate. Still, if we compare apples to apples, well, Microsoft's projected long-term growth rate is only 11.3%, versus 11.8% for the S&P as a whole. And Microsoft pays a 1.2% dividend, versus 1.9% for the average S&P 500 stock.
But if Microsoft is growing slower than other companies, and paying a smaller dividend than other companies, too, it's hard to defend the stock's valuation of nearly 20% more than other stocks. Sure, 25x earnings may not look like too steep a price to pay for a tech leader like Microsoft, especially not in the context of some of the tech stock valuations we saw during the pandemic.
But looks can be deceiving.
