Source: PaxForex Premium Analytics Portal, Fundamental Insight
Investors are currently exhibiting great enthusiasm for Microsoft. The tech giant has achieved impressive gains of 42% in 2023, outperforming the 30% gain of the Nasdaq Composite index. Recently, the stock even surpassed its previous all-time highs from early 2022.
Undoubtedly, the broader rally in the technology sector contributes to Microsoft's exceptional performance. However, it's important to recognize why Wall Street is particularly excited about this company's potential. Microsoft has a wide range of significant growth opportunities in areas such as cloud services, artificial intelligence (AI), video gaming, and productivity software.
However, it is crucial for investors to note that the latest rally has driven the stock's valuation to higher levels. With this valuation challenge in mind, let's examine some reasons to consider buying the stock, as well as a few factors that warrant exercising caution.
Despite certain sales niches, such as personal computing software and tech devices, experiencing a decline, Microsoft continues to demonstrate strong growth momentum.
In the recent selling period that extended through late March, Microsoft witnessed a noteworthy 10% increase in overall revenue, driven by a significant 25% year-over-year spike in the cloud services segment. This growth acceleration is particularly encouraging, especially when compared to the previous quarter, where revenue only rose by 2% year over year.
One of the most compelling reasons to be bullish on this stock is Microsoft's robust financial position. The company generated a substantial $34 billion of operating cash in the past six months, with operating income reaching $42 billion. This equates to roughly 40% of sales during that period.
The remarkable level of earnings and profitability exhibited by Microsoft sets it apart from many other companies in the market. It indicates that the company possesses incredible competitive advantages, reinforcing its position as a formidable player in the industry.
However, it is important to acknowledge that Microsoft has faced some challenges recently. Alongside the sales declines in the PC and hardware divisions, the company is experiencing reduced enthusiasm among certain large enterprises in terms of their spending. Cost-cutting measures have led to slower order volumes and put pressure on contract sizes. Additionally, it may take several more quarters for the cyclical downturns in the PC market to reverse.
From a valuation standpoint, the stock is currently priced at a relatively high 12 times annual sales, which is not far from the all-time high valuation (a P/S ratio of 15) witnessed during the high-growth phases of the pandemic. In comparison, other tech giants like Apple are valued at 8 times annual revenue, and Amazon has a P/S ratio of less than 3, making them comparatively cheaper options.
Nonetheless, Microsoft has the potential to justify its premium valuation, particularly if advancements in artificial intelligence (AI) unlock a significant portion of the anticipated software benefits that executives are currently predicting. CEO Satya Nadella expressed that the industry is on the brink of "a new era of computing" in late April, and this optimism surrounding the phase is clearly contributing to the stock rally this year.
Risk-averse investors might prefer to wait for a more favorable price, which could coincide with market volatility. Moreover, there may be inevitable bumps in Microsoft's growth trajectory, including when the company announces its fourth-quarter results in late July.
However, patient investors are likely to generate solid profits from holding this stock, even at the current elevated valuation. Microsoft's growth prospects and ample cash flow should support returns in the coming years, even if expectations regarding AI and cloud software turn out to be slightly exaggerated.
As long as the price is above 323.00, follow the recommendations below:
- Time frame: D1
- Recommendation: long position
- Entry point: 336.97
- Take Profit 1: 350.00
- Take Profit 2: 365.00
Alternative scenario:
If the level of 323.00 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation: short position
- Entry point: 323.00
- Take Profit 1: 312.00
- Take Profit 2: 300.00
