MSFT with Nobias technology: Is Microsoft A Buy After Its 35% Year-To-Date Rally?
Microsoft (MSFT) has become the posterboy for the perfect “old tech” to growth tech transformation under its current CEO, Satya Nadella. Prior to Nadella taking over the reins in 2014, Microsoft was largely thought of as a slow growth behemoth which had been left behind in the digital age. From 2012-2016, the company’s annual bottom-line growth results were relatively poor, coming in at 3%, -7%, 2%, 0%, and 6%, meaning that over this 5-year period, MSFT’s annual earnings-per-share was completely stagnant. However, since 2016, Nadella’s cloud-centric restructuring has allowed MSFT to produce strong double digit growth every single year and Microsoft’s share price (and valuation) have benefitted immensely. When Nadella took over, MSFT was trading for approximately 16x earnings. Today, the market has applied a 37x premium on shares, representing a massive sentiment shift. And recently, MSFT hit new all-time highs because of news surrounding the pricing of its Office software suite. With this in mind, we wanted to take a look at what the credible authors that the Nobias algorithm tracks have had to say about the company, to see whether or not this is a stock investors should consider adding here after its 35% year-to-date rally.
Adam Levy, a Nobias 4-star rated analyst, recently published a report at The Motley Fool which highlighted Microsoft’s Office move. He said, “Microsoft announced the first price increase for its Microsoft 365 and Office 365 subscriptions since the subscription offering was first introduced more than a decade ago. In its announcement, Microsoft pointed out all the additional value it's added to the software suite over the last 10 years, justifying its price increase.”
Levy notes that MSFT is not increasing prices for the consumer version of its software suite, but instead, the products offered to its commercial clients. He believes that this move will result in top and bottom-line growth for the company; however, he says, investors will have to be patient, because while the move will result in higher pricing for the 300 million commercial clients that Microsoft currently services, “they won't all see the price increase at once. Microsoft locks in long-term contracts with businesses, so the full impact probably won't show up until well into fiscal 2023.” But, the potential positive impacts here should be worth the wait.
Levy says, “When the price increase is fully rolled out, the 300 million existing subscribers will be paying at least $1 more per month, but $2 or $3 in most cases. Also consider that the price increases for the lower tiers of service are more substantial (on a percentage basis) than the higher tiers. That could push more businesses to opt for higher-tier services, producing further revenue growth.” He continues, writing, “An average increase of $2 per user would translate into $7.2 billion in additional revenue. That's on top of any organic subscriber growth the company can produce. For reference, Office 365 Commercial's revenue increased 25% year over year in the fourth quarter. And during the company's fourth quarter earnings call, CEO Satya Nadella said it's seeing double-digit year-over-year seat growth across every segment.”
Levy highlights the opinion of famous technology analyst, Daniel Ives of Wedbush Securities, who recently said that he believes the move could add $5 billion in additional revenue in Microsoft’s fiscal 2022. With that in mind, Levy concludes, “Microsoft produced an operating income of nearly $70 billion in fiscal 2021. Adding $4 billion or $5 billion in additional operating income with just a price increase is a 6% or 7% increase in operating income. And don't forget the service is continuing to grow subscriptions. As such, the price increase should compound earnings growth for the tech stock for years to come.”
Positive compounding being produced by Microsoft’s office suite is great, but what has really driven MSFT’s share price over the last 5 years or so has been its cloud expansion. In a recent article at investors.com, Patrick Seitz, a Nobias 4-star rated analyst, highlighted the company’s strong cloud position saying, “Amazon.com's (AMZN) Amazon Web Services is the world's largest provider of cloud infrastructure services. In the second quarter, AWS had 31% market share, according to research firm Canalys. Microsoft was in second place with 22% market share.”
Being that the overall cloud market continues to expand at a rapid pace, Microsoft’s second place position is enviable. And, in recent quarters, MSFT’s cloud growth rate has exceeded Amazon’s, pointing towards the notion that MSFT is picking up market share. Cloud strength has not only increased Microsoft’s fundamental growth outlook, but also its valuation premium.
Seitz highlighted MSFT’s Q2 results, noting that on July 27th, the company beat analyst expectations on both the top and bottom lines. He wrote, “Microsoft earned $2.17 a share on sales of $46.2 billion in the June quarter. Analysts had predicted Microsoft earnings of $1.92 a share on sales of $44.2 billion. On a year-over-year basis, Microsoft earnings rose 49% while sales increased 21%.” And looking forward, he says, “For the September quarter, Microsoft expects to generate sales of $43.75 billion, up 18% from the same period last year. That's based on the midpoint of its guidance. Wall Street had predicted $42.5 billion in sales for Microsoft's fiscal first quarter.”
This forward looking growth has helped MSFT to maintain its positive momentum, even after posting market beating returns throughout 2021. Seitz highlights the company’s technical momentum metrics, saying, “Microsoft stock has a good IBD Relative Strength Rating of 86 out of 99. The best growth stocks typically have RS Ratings of at least 80. The Relative Strength rating shows how a stock's price performance stacks up against all other stocks over the last 52 weeks.”
But, even with all of MSFT’s bullish growth tailwinds in place, Seitz says that this positive momentum has pushed MSFT shares up above a zone where he feels comfortable buying, concluding his piece by saying, “Microsoft stock is not a buy right now. It is trading above the 5% buy zone of its breakout, which extends to 276.45, based on IBD trading guidelines. MSFT stock ended the regular session Aug. 20 at 304.36.”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
From a fundamental perspective, it appears that MSFT’s valuation is high as well. Microsoft currently trades for 34.3x its forward looking fiscal 2022 consensus earnings-per-share expectations of $8.75. This multiple is well above MSFT’s trailing 3, 5, and 10 year average price-to-earnings multiples of 29.6x, 24.8x, and 18.7x, respectively. As you can see, as time has moved on, MSFT’s digital transformation has led to a higher and higher average premium. This is due to the company’s relative strength (MSFT remains one of just 2 companies in the entire world to have a AAA-rated balance sheet; Johnson and Johnson (JNJ) is the other) and its strong double digit growth.
But, looking ahead, analysts are calling for its bottom-line growth to slow to 10% in 2022 and 15% in 2023; both figures below the 23.4% 5-year average growth rate, which implies that the current growth premium may be too high. There is little doubt that this is a blue chip company from a quality standpoint, but MSFT’s high share price has caused certain investors to place a pause on recent buying (Seitz points out that the stock has a below average grade when it comes to institutional buying over the past 13 weeks).
However, when looking at the Nobias analyst community, it appears that the valuation concerns have not changed the overall bullish sentiment surrounding this stock. 95% of the credible author community that we track have a “Bullish” rating on MSFT shares. And, the average price target for MSFT amongst the credible authors that we track is $331.60, which relative to MSFT’s current share price of $295.71, represents upside potential of approximately 11%.
Disclosure: Nicholas Ward is long AMZN, JNJ, and MSFT. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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