Few public companies dominated the headlines in 2023 more than Microsoft (MSFT +1.98%), whether it was its involvement with OpenAI's Chat GPT, its successful $69 billion acquisition of Activision Blizzard, or antitrust probes. Investors in the nearly $3 trillion tech giant were rewarded handsomely with a total return of 56%, outpacing the benchmark S&P 500 by roughly 32%.
Still, shareholders and prospective investors are reasonable to ask the question: How much bigger can Microsoft get? So, let's look at its recent key financial metrics, what could go wrong, and its future growth potential.
Microsoft keeps getting bigger
Looking at Microsoft's top and bottom lines over recent years, you might be struck by the company's sheer growth. To illustrate, Microsoft generated $110.3 billion in revenue for its fiscal year 2018 and $211.9 billion in revenue for its fiscal year 2023, representing an compound annual growth rate (CAGR) of 14%.
Notably, big tech competitor Alphabet (GOOG +3.25%)(GOOGL +3.37%) grew revenue faster over its past five reported years with a CAGR of 20.6%, while Apple (AAPL 0.28%) produced a revenue CAGR of 7.6%. Additionally, Microsoft management has guided for double-digit revenue growth for its full-year fiscal 2024, indicating its growth will likely continue at its impressive pace for at least another year.
Turning our attention to profitability, Microsoft generated $16.6 billion in net income for its fiscal year 2018 and $73.4 billion in its fiscal year 2023, equating to an impressive CAGR of 34.6%. For comparison, Alphabet's and Apple's five-year net income CAGRs are 36.4% and 10.3%, respectively.
MSFT Net Income (Annual) data by YCharts
As a result of Microsoft's cash generation, its balance sheet is strong, with $72.4 billion in net cash (cash and cash equivalents minus total debt) as of its most recently reported quarter. Notably, that cash position was before Microsoft's successful $69 billion acquisition of Activision Blizzard, but still healthy enough to cover the entire cost without going into a net debt. Considering Microsoft's consistently growing profits, the company should be well positioned to rebuild its pile of cash while continuing to return capital to shareholders and fund future growth instead of worrying about paying down its debt in a high interest rate environment.
What could go wrong for Microsoft?
Microsoft is not a cheap stock, any way you slice it, which means investors risk potential losses if and when the market resets its expectations for the stock. Using the valuation metric forward price-to-earnings (P/E) ratio -- a company's stock price compared to its expected earnings over the next 12 months -- Microsoft currently trades at 33 times forward earnings. That is higher than its competitors Alphabet and Apple at 24 and 29, respectively, and it is also significantly higher than Microsoft's five-year P/E ratio average of 31.
MSFT PE Ratio (Forward) data by YCharts
Another potential headache for Microsoft and its shareholders is antitrust concerns. Anytime a company is perceived as too big, regulators across the globe take notice, worrying that competitors won't stand a chance to compete fairly against a company like Microsoft. Most recently, Microsoft has faced antitrust concerns from the Federal Trade Commission and the U.K.'s Competition and Markets Authority over its ties to OpenAI. Additionally, Microsoft was forced to unbundle its Teams product from Microsoft Office after competitor Salesforce complained Microsoft unfairly integrated its workplace chat and video app, hurting Salesforce's Slack product.
Microsoft has dealt with many antitrust concerns as a public company, paying billions in fines. Notably, the company paid $2.4 billion to the European Commission over the previous decade for breaching E.U. competition rules. Beyond tying up costly resources, there is the threat that one regulation body will finally grow tired of the tech company and force it to spin off or break up a portion of its business.
Here's why Microsoft is trading at a high valuation
As alluded to, Microsoft is making a big bet on its gaming and artificial intelligence sectors to fuel future growth. With its acquisition of Activision Blizzard, the gaming company generated $7.5 billion in revenue and $1.5 billion in net income during its final year as a public company. It's easy to see how Microsoft will bolster its current gaming portfolio with established franchises like Call of Duty and complement its video game console, Xbox.
NASDAQ: MSFT
Key Data Points
What has really excited investors and why Microsoft is trading at a higher-than-usual valuation is its $13 billion investment in OpenAI. The generative artificial intelligence company's ChatGPT product has been called a game-changer by industry experts, and its valuation has skyrocketed from $14 billion in 2021 to an estimated $100 billion or higher as of late December. Reportedly, OpenAI is generating revenue at the pace of $1.3 billion annually, which is already 30% higher than this past summer.
Is Microsoft stock a buy today?
Generally, investors are wise to be cautious with stocks that surge quickly in a short amount of time, especially when speculation and hype drive prices up. While Microsoft is a long-dominant tech company -- it even pays a modest 0.8% annual dividend yield -- there's no denying its valuation is unusually high right now.
For prospective investors, you may be wise to add Microsoft to your watch list, waiting for a better opportunity to buy the otherwise great company.
