Microsoft (MSFT 0.17%), a "Magnificent Seven" stock that saw its stock rise more than 200% over the last five years, recently experienced something pretty rare for a company of its stature: a downgrade from a Wall Street analyst. Gil Luria, managing director at D.A. Davidson, recently cut his rating on the tech conglomerate from "buy" to "neutral." Luria maintained his $475 price target for the company, which still implies upside from the current price. Of the 59 analysts covering Microsoft, 55 rate the stock as a buy and three as a hold.
Should investors be worried about this recent downgrade? Let's take a look.
Losing the lead on AI?
Luria's downgrade is predicated on the idea that Microsoft may have lost its edge on the artificial intelligence front, which will continue to be a critical catalyst for large tech stocks.
Last year, Microsoft was all the rage when it came to AI. The company integrated OpenAI's capabilities into its Azure platform to allow developers to build new applications that could automate tasks and leverage massive amounts of data. The company also launched its own generative AI-powered platform called Microsoft Copilot and integrated it with other classic applications like Microsoft Teams, where it can accomplish tasks such as creating overviews and transcripts of meetings.
However, this lead may be dissipating, according to Luria, who said that Alphabet's Google Cloud and Amazon Web Services are now adding business at a similar clip. Furthermore, Luria said he thinks that Google and Amazon are doing a better job of investing in their own in-house chips than Microsoft, giving those companies a potential cost advantage. Investors are still baking in a premium valuation for Microsoft based on this perceived AI lead, Luria said.
Still one of the best businesses in the world
Even with the possibility that Microsoft is losing its edge in the AI realm, Microsoft has still developed one of the best businesses in the world and is a company that the broader business world depends on to run its day-to-day operations.
Microsoft operates several businesses that provide good revenue diversity within the tech sector. The company's powerhouse revenue generators include its server products and cloud services capabilities that people can build and manage applications on, as well as its suite of office products that businesses use to accomplish daily tasks. The company has also seen strong growth in recent years in gaming, largely due to the Xbox console, and social media thanks to LinkedIn.
The financials remain compelling. In fiscal-year 2024, Microsoft grew diluted earnings per share by 20% year over year, with revenue up 16%. The company has recently been generating operating margins in the mid-40s percentile with annual free cash flow of more than $74 billion in 2024. This allows the company to return a lot of capital to shareholders. Recently, Microsoft announced a new share repurchase program that allows the company to buy back up to $60 billion of stock.
Should investors be worried?
I think Luria certainly brings up some interesting points that investors should pay attention to. Microsoft also trades at close to 33 times forward earnings, so a disappointing earnings season or further evidence of struggles in the AI battle could make the stock susceptible to a pullback in the near term.
But long term, Microsoft still offers one of the most enviable moats in the world. And if the company is truly struggling with its AI capabilities, it has the resources to right the ship, so I think long-term investors can continue to hold the stock without too much concern.
