Microsoft's (MSFT -2.45%) stock has performed well this year, rising 34.55% compared to the S&P 500's 9.2% increase. However, some believe the stock is overvalued and has little room for further growth. They point to the company's consensus analyst price target of $323.28, which suggests little upside potential over the next year.
Here's why you should disregard analysts' price targets and focus on two long-term growth drivers instead.
Invest for the long term
An analyst consensus price target is the average price prediction of all analysts covering a particular stock. It is typically a 12-month forecast that encourages short-term investing. However, there are several reasons why short-term investing can be detrimental to many investors, with the most significant being it is more risky than long-term investing.
Stock prices can fluctuate significantly in a brief period, meaning short-term investors are more likely to lose money than long-term investors. Additionally, short-term investors are more likely to make emotional decisions and be affected by market fluctuations. As a result, they may sell their investments when prices fall, even if they believe that a stock still has good long-term prospects.
Therefore, it is often best to focus on a company's long-term considerations, and the two most significant long-term growth drivers for Microsoft are digital transformation and artificial intelligence (AI).
Digital transformation
Digital transformation is a broad term for using electronic systems, devices, and cloud computing to change business operations and customer experiences. It can involve adopting new technologies, re-engineering business processes, and creating new products and services.
Microsoft derives much of its market value from being one of the largest digital transformation infrastructure companies. It offers popular digital transformation tools like:
- Microsoft Azure: A cloud computing platform that provides businesses with scalable, cost-effective, and secure IT resources
- Microsoft Dynamics 365: A business application suite that helps businesses improve customer service, increase sales, and reduce costs
- Microsoft Power Platform: Helps businesses build apps, automate tasks, and analyze data
- Microsoft Teams: A collaboration platform for businesses
Microsoft maintains a significant advantage over its competitors due to its decades-old customer relationships with many companies through its Windows Server product line and other traditional software like Office. So when many of its old clients are ready to transform digitally, they often choose Microsoft because they trust the company's products and services, making it easier to transition. Additionally, it has a solid history of innovation, which gives its customers confidence that they are investing in a reliable partner.
The digital transformation market is massive and rapidly growing. Statista has forecast this market to grow at a compound annual growth rate (CAGR) of 16.32% from $2.16 trillion in 2023 to $3.4 trillion by 2026. So you can expect digital transformation to drive a huge chunk of this company's growth for the foreseeable future.
Artificial intelligence
In Microsoft's fiscal third-quarter 2023 earnings report, CEO Satya Nadella highlighted artificial intelligence (AI) as an area where the company wants to be a leader. One reason why Nadella focused on AI is that it can be a significant factor in the growth of cloud computing. Modern AI technology requires enormous computing resources, which cloud computing provides on demand. It also needs to access large amounts of data, which cloud computing can store. Cloud computing also makes sharing AI models and data with others simple, an essential quality for collaboration and innovation.
Nadella hinted at AI driving cloud growth when he said the following on the company's latest earnings call:
Azure took share as customers continue to choose our ubiquitous computing fabric from cloud to edge, especially as every application becomes AI-powered. We have the most powerful AI infrastructure and it's being used by our partner OpenAI as well as Nvidia and leading AI start-ups like Adept and Inflection to train large models. Our Azure OpenAI service brings together our advanced models including ChatGBT and GPT-4 with the enterprise capabilities of Azure.
Many technology experts predict the AI market will increase rapidly over the next decade. For example, Next Move Strategy Consulting valued the AI market at $142.32 billion in 2022, and it projects the market to grow to approximately $1.8 trillion by 2030, a 37.8% CAGR over eight years. So expect AI to be a massive growth driver for Microsoft as the technology proliferates.
Short-term headwinds
IDC predicts that cloud software revenue will grow by 19% in 2023, down from 25% in 2022. This slowdown is primarily due to global economic uncertainty, causing businesses to be more cautious about investing in new technologies. During the third-quarter 2023 earnings call, CFO Amy Hood admitted that Azure customers "continued to exercise some caution."
You can see the impact of the terrible economic environment on the company's cloud, digital transformation, and AI-related businesses in the chart below.
MSFT Revenue (Quarterly YoY Growth) data by YCharts
Despite the slowdown, industry experts expect the cloud software market to grow significantly in the coming years due to the continued demand for cloud-based solutions from businesses of all sizes.
Why you should put it on your buy list
Microsoft is on the cutting edge of two significant business trends in the early innings. So if you are an investor searching for a reliable company with the potential for substantial long-term gains, there are few better choices than Microsoft.
