What happened
Shares of Microsoft (MSFT -0.49%) climbed 15.6% last month, according to data provided by S&P Global Market Intelligence. Investors responded favorably to news related to the company's proposed acquisition of gaming leader Activision Blizzard. The stock also charged higher thanks to momentum in the tech sector, which was driven by changing economic expectations.
So what
March was a relatively quiet news month for Microsoft, which published quarterly financials in the prior month. There were some developments regarding the company's planned acquisition of video game developer Activision Blizzard. The deal was announced over a year ago, but it's been delayed as various governments scrutinize the deal under antitrust regulations. There was positive news on that front, as U.K. regulators officially dropped some of their concerns that have inhibited the combination. Microsoft continued to forward the deal by securing a long-term streaming deal for Activision's popular Call of Duty franchise in Japan. Activision would represent under 2% of Microsoft's total revenue, so it's not exactly a game changer for the tech giant. Still, the deal would make Microsoft one of the largest players in the high-growth gaming industry, enhancing one of its lucrative business segments.
Microsoft has also enjoyed some momentum thanks to its burgeoning artificial intelligence (AI) business. The company has established itself as a major player in the space thanks to its partial ownership of OpenAI and the resulting collaborations with the AI software developer. Investors are enamored with the potential business applications of AI right now, and announcements on the topic have been moving share prices. Microsoft hosted a "fireside chat" in March, during which it said its Office suite would soon get an upgrade with AI integrations.
Image source: Getty Images.
None of this was transformative news, but it was enough to keep the ball rolling. Microsoft also benefited from sector-wide gains driven by macroeconomic forces. Tech stocks rose following the Federal Reserve's March press conference, as investors gained hope that rate hikes would stop in the second half of the year. That would remove an important factor that's been keeping growth stock valuations lower.
Now what
Microsoft has been among the giant tech leaders for decades, but its business is now more diversified than ever. It's among the leaders in numerous important market segments, including AI, gaming, productivity software, cloud services, web search, and digital advertising. As a result, it's a fairly stable cash-flow producer that's also outpacing broader economic growth. That's a rare combination, and it's appealing for a wide variety of investment strategies.
Unfortunately, this isn't a secret, and investors have to pay a premium to buy Microsoft shares. The stock's forward P/E ratio is now above 30, which is a bit high relative to consensus growth forecasts.
MSFT PE Ratio (Forward) data by YCharts
The recent valuation increase means that strong performance is already assumed in the share price, shifting the risk-reward balance unfavorably. Failure to meet the newly elevated expectations could trigger a sell-off.
Long-term investors shouldn't be scared to buy a high-conviction stock just because it's modestly overvalued. However, the new valuation means that buyers need to be prepared for potential volatility, especially if the economy dips into a recession later this year.
