There seems to be a growing consensus on Wall Street about Microsoft (MSFT -1.00%) stock. Shares have trounced the wider market so far in 2023, up around 40%, compared to the 31% spike in the Nasdaq Composite Index through early July.
Bulls are convinced that the software giant will see strong sales growth, potentially ignited by a rush of new productivity from artificial intelligence (AI) and machine learning. Optimists see a highly profitable business that generates unusually high levels of cash flow, too.
Bears might have a point, though, when they argue that Microsoft stock looks expensive, given its modest demand trends today. But which camp is right? Let's dive right in.
Bears: It's too expensive
The bearish argument revolves around the stock's elevated valuation in comparison to sluggish sales trends. Revenue rose just 10% in the most recent quarter, after all, and Microsoft endured a 7% drop in its PC division.
The Windows segment shrank at an even faster rate, and the video game unit grew by a modest 5%. It's really Microsoft's cloud services and cybersecurity platforms that are showing the best growth right now.
Operating profit margin is down in recent quarters, too, falling to 41% of sales over the past nine months, compared to 43% of sales in the year-ago period. It's hard to justify the stock's rally and its rising valuation judging by just those latest operating trends. Microsoft shares are valued at over 12x annual sales today, up from a price-to-sales ratio (P/S) of below 9 earlier in the year.
Bulls: The many ways to grow
On the bullish side, there's clearly a lot of value in Microsoft's enterprise cloud platform, which last quarter grew a blazing 25% year over year. These gains came even though many large companies are pulling back on IT spending, so they're prioritizing Microsoft's software-as-a-service products.
You'll also have a hard time finding a business with better financial strength. Even after declining in 2023, Microsoft's 41% operating profit margin makes it one of the most efficient companies in the entire market. It generates tons of cash, too, including $59 billion of operating cash flow over the first three quarters of fiscal 2023.
These wins give management incredible flexibility to spend aggressively in growth areas like AI, virtual reality (VR), and cybersecurity. They also point to increasing cash returns to shareholders, as evidenced by the company's 10% dividend hike this year. Investors tend to do well by holding a market-leading stock like this and allowing dividends and stock buybacks to amplify returns over the long term.
Where we're headed
Cautious investors might want to wait for a potentially better price for Microsoft's stock, which might arrive if the company fails to meet the high expectations placed on it for its next few quarterly updates. Even a small reduction in its earnings outlook could push shares down from this elevated perch.
On the other hand, Microsoft's best growth industries have many years of expansion ahead of them, so you're unlikely to see a big difference in your returns if you pay just a bit more of a premium for the stock. Patient investors can buy the stock today and simply hold for long enough to allow compounding to do its magic. The bulls are right in this case.
