Microsoft's (MSFT 0.37%) stock was already on the rise in 2023 (up 17%) when it reported earnings for the fiscal third quarter of 2023 (ended March 31) on April 25. After the report's release, its stock shot another 8% higher as investors celebrated its results amid what has become a brutal bear market for Microsoft and its peers.
Does the latest report and the resulting bump suggest Microsoft stock is trading at a premium and should be avoided right now, or is the stock at the beginning of its next bull market and investors should jump in and hold on?
The fiscal Q3 report
For the third quarter of fiscal 2023, Microsoft reported revenue of $53 billion, a 7% increase year over year. The intelligent cloud and the productivity and business processes segments each grew revenues by double-digit percentages, with Azure and other cloud services reporting 27% year-over-year growth. Still, the 9% year-over-year decline in the personal computing segment weighed on the overall top line.
In the quarter, Microsoft managed to boost bottom-line earnings by limiting growth in the cost of revenue and operating expenses. That resulted in a net income of more than $18 billion, a year-over-year increase of 10%.
What's driving Microsoft's growth?
One important change agent for Microsoft stock is undoubtedly artificial intelligence (AI). That technology has played a critical role in Azure as well as its suite of software products.
Among the functions powered by AI is its ability to identify and respond to security threats, help users find needed data, and better answer customer questions. Also, it empowers Microsoft 365 Copilot, supercharging its productivity software to perform tasks such as turning documents into presentations, summarizing data, and helping users write emails.
Nonetheless, its most dramatic change came from a surprising area: search. The company's alliance with OpenAI resulted in ChatGPT software powering Microsoft's search engine Bing, possibly giving Bing an edge over Alphabet's Google search. Whether it is wresting search market share from Google is unclear, but downloads of the Bing mobile app rose fourfold in two months.
The effects on Microsoft stock have become noticeable over the last few months. Alphabet and Microsoft delivered roughly the same return since the beginning of the pandemic. However, Microsoft's performance has slightly exceeded Alphabet's, since both stocks reached a 52-week low in early November.
Can the increases continue?
The increase for Microsoft continued, as the stock shot 8% higher following the report. This is a stark contrast to Alphabet, which reported earnings at the same time and did not see its stock move significantly following its earnings news.
Nonetheless, Microsoft's valuation might have moved ahead of itself. Its P/E ratio now stands at 33. While lower than cloud peer Amazon, its valuation is well ahead of Alphabet and longtime rival Apple. This is not to say Microsoft is in any serious trouble, but its valuation may warrant a closer look at the stock, given where it stands in comparison with its rivals.
MSFT PE Ratio data by YCharts
Microsoft is a hold
Given current conditions, investors interested in Microsoft may want to wait for a pullback before adding shares. Admittedly, its cloud computing business has shown resilience, and ChatGPT pulled Bing ahead of the seemingly untouchable Google search.
However, Microsoft has risen significantly over the last few months. And while that has increased the valuation, its profit growth may not support the current earnings multiple. Hence, investors might want to wait for a pullback before adding more shares of the AI stock.
