Source: PaxForex Premium Analytics Portal, Fundamental Insight
The swift integration of artificial intelligence (AI) has significantly benefited Microsoft, with the stock soaring 72% since 2022. However, some investors may question whether it remains a sound investment, especially given the current price-to-earnings (P/E) ratio of 34, which is at the upper end of its decade-long history and surpasses the S&P 500's P/E of 30.
Bill Gates, co-founder and former CEO, has generously donated billions in Microsoft stock to the Bill & Melinda Gates Foundation. Although the foundation holds a substantial stake in Microsoft, it has divested shares in each of the past four quarters. This trend of selling Microsoft shares reflects the foundation's ongoing philanthropic activities. On the other hand, other influential investors, such as Chase Coleman's Tiger Global Management, retained a $3 billion interest in the company during the third quarter, while John Armitage's Egerton Capital increased its holdings.
The current momentum behind Microsoft makes it appealing to consider following these billionaire investors into the stock. Nevertheless, paying a premium for shares is challenging, especially in light of the uncertainty regarding the impact of Microsoft's AI initiatives on its earnings growth. The Gates Foundation's recent sales could indicate a cautious outlook for stock returns, potentially signaling a warning for investors.
From a revenue growth standpoint, Microsoft's performance is robust, with cloud revenue climbing 22% year-over-year in the first quarter to $39 billion, driven by strong demand for Azure services. Additionally, the personal computing sector, including the Xbox business, has seen significant growth following the acquisition of Activision Blizzard.
Despite the elevated P/E, Microsoft's impressive cash flow may provide a reason for investors to hold onto the stock. The company boasts high margins, generating $72 billion in free cash flow over the past year, and returning $9 billion to shareholders through dividends and share buybacks in the last quarter.
Microsoft is effectively returning cash to shareholders while simultaneously investing heavily in AI infrastructure, having already embedded AI services across its software offerings. AI contributed 12 percentage points to the 33% year-over-year revenue increase in Azure last quarter, suggesting that the company is poised to capitalize on AI to enhance long-term revenue growth.
However, investors should note that despite the increased demand for AI services, there has been limited growth on the earnings front. Although total revenue rose 16% year-over-year last quarter, AI investments led to a 7% decline in free cash flow compared to the same quarter last year. This situation may be temporary, but the current impact on cash flow could affect stock performance in the short term.
Reflecting on the Gates Foundation's share sales, it's interesting to observe that these transactions often align with the stock’s market value. In late 2022, when shares were undervalued, the foundation refrained from selling, recognizing the stock's potential for growth. It suggests that the foundation is acutely aware of Microsoft's value and return potential.
Looking ahead, Wall Street anticipates nearly 11% earnings growth for Microsoft in fiscal 2025 (ending June). However, this rate of growth may not be sufficient to justify the stock's lofty P/E ratio, particularly when other notable “Magnificent Seven” stocks, like Meta Platforms and Alphabet, are trading at more appealing valuations and promising better earnings growth.
For existing shareholders, it may be prudent to hold onto their shares despite the stock’s recent high valuation, rather than incurring capital gains taxes from selling. Microsoft represents a strong business worth maintaining in a portfolio. Yet for new investors considering entry into the stock market, exploring alternative opportunities could be advisable.
As long as the price is above 405.00, follow the recommendations below:
- Time frame: D1
- Recommendation: long position
- Entry point: 416.41
- Take Profit 1: 425.00
- Take Profit 2: 435.00
Alternative scenario:
If the level of 405.00 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation: short position
- Entry point: 405.00
- Take Profit 1: 400.00
- Take Profit 2: 390.00
