Microsoft (MSFT -0.09%) has been a standout growth stock in 2025, adding more than $830 billion in market cap from the start of the year through the end of July. But some investors may be concerned that Microsoft is running up too far too fast, setting the stage for a pullback due to valuation concerns.
Here's why Microsoft's valuation is pretty much the only thing holding it back from being a screaming buy, and why the company can grow into its valuation over time.
Image source: Getty Images.
Microsoft and the effectiveness of consistent compounding
Microsoft is a textbook example of the power of compounding solid growth over an extended period.
Over the last decade, cloud and artificial intelligence (AI) have been the two biggest drivers of Microsoft's sales and earnings growth. An honorable mention is the vertical integration of Microsoft's gaming business (under its More Personal Computing segment) through Xbox, content services, and the acquisition of Activision Blizzard.
Over the last decade, Microsoft's revenue more than tripled, and its net income is up more than sixfold. The company generated more net income in fiscal 2025 than revenue in fiscal 2017 -- illustrating the impact of high-margin growth on Microsoft's bottom line.
|
Fiscal Year |
2016 |
2017 |
2018 |
2019 |
2020 |
2021 |
2022 |
2023 |
2024 |
2025 |
|---|---|---|---|---|---|---|---|---|---|---|
|
Revenue (billions) |
$85.3 |
$90 |
$110.4 |
$125.8 |
$143 |
$168.1 |
$198.3 |
$211.9 |
$245.1 |
$281.7 |
|
Net income (billions) |
$16.8 |
$21.2 |
$16.6 |
$39.2 |
$44.3 |
$69.9 |
$72.7 |
$72.4 |
$88.1 |
$101.8 |
|
Net profit margin |
19.7% |
23.6% |
15% |
31.2% |
31% |
41.6% |
36.7% |
34.2% |
35.9% |
36.1% |
Data source: Microsoft.
Microsoft has been consistently growing revenue, but net income is growing even faster. In fiscal 2025, Microsoft raked in around $0.36 of every dollar in revenue into bottom-line profit. That's profit net of all expenses -- including taxes. That's an incredible achievement, especially considering how much Microsoft's expenses have gone up in recent years.
Microsoft is relatively expensive
Microsoft's rapid growth in the second half of the 2010s was driven by Azure and the widespread adoption of cloud computing. But everything has been clicking for Microsoft over the last three years. The company grew revenue by roughly 15% in fiscal 2023, 2024, and now 2025 -- surpassing $100 billion net income for a fiscal year for the first time in company history.
Microsoft's stock price responded to these impeccable results by compounding several-fold. And for a while, the valuation was arguably too cheap to ignore.
But now, Microsoft is being valued for what it has become, which is an ultra-high-margin, diversified business growing revenue in the mid-teens rather than the high single digits or low teens of years past. This valuation expansion has pushed Microsoft's price-to-earnings (P/E) ratio close to 40 -- whereas its 10-year median P/E is 33.1.
Growing into its valuation
Microsoft has never been a better company, but it has also become a much more expensive stock. Over time, Microsoft has justified its high valuation by consistently growing revenue and earnings. And now more than ever there's reason to believe that can continue.
Anything can happen in the stock market in the short term. But when it comes to long-term investing, buying ultra-high-quality companies at premium prices is usually worth it.
As an example, if Microsoft keeps growing earnings at 15% per year, earnings will double in five years.
If the stock price did nothing over that period, the P/E would be cut in half, down to around 20.
If the stock price gained another 50%, the P/E would fall to 30 -- a discount to Microsoft's historical average.
Justifying a premium price
Microsoft won't look expensive if it keeps up this pace of earnings growth. The power of compound returns is why the market is willing to pay a high price for Microsoft today.
As an individual investor, you have the luxury of choosing whether to agree with a prevailing sentiment. Right now, the sentiment is optimistic on Microsoft. So to buy the stock requires a long-term time horizon and the conviction that the optimism is grounded in logic rather than greed.
But if you believe that a lot of Microsoft's growth is due to a surge in AI adoption that will cool off as the technology becomes widespread, then it's perfectly all right to take a wait-and-see approach to the stock.
