Microsoft Corporation (NASDAQ:MSFT) has seen a slight pullback in its share price over the past week, leaving some to question whether or not its time to take on a position.
There is a lot to like about MSFT stock, the company has a unique business model, a pretty solid moat and pays out a relatively high dividend for a tech firm.
However, although I think Microsoft is solid company, I don’t think its poised to deliver the kind of growth its price would suggest.
At the moment, Microsoft stock has a price-earnings ratio of 27 and trades at roughly 22 times its forecasted earnings. While not even close to the kind of valuation you see for a high-growth stock like Amazon.com, Inc. (NASDAQ:AMZN), it’s not far off say, Alphabet Inc (NASDAQ:GOOGL), which trades at 30 times its forecasted earnings.
The trouble is, although Microsoft has done a lot to turn itself around since the tech bubble of 2000, the company doesn’t really have any dazzling growth prospects ahead.
Microsoft’s Office products have been around since the 90s and several generations have grown up using them. Familiarity makes Office a good choice for businesses looking to cut down on time showing employees around basic programs. It’s also a handy choice for individuals who don’t want to make the switch and learn a different program.
Microsoft has converted the programs into subscription-based downloads, which means it collects a revenue continuously rather than at the point of purchase. Not only that, Microsoft uses these subscriptions to interest people in its cloud platform.
Another big reason to like MSFT stock is the firm’s cloud computing platform, Azure. Azure has become the second leader in the industry, after Amazon Web Services, and there are some who believe Azure has even started to overtake AWS.
Cloud computing is undoubtedly an area with huge growth potential, and its definitely a plus Microsoft has staked its claim. However, Azure isn’t a huge part of Microsoft’s business at this point, so its hard to imagine it being a driving force of growth for the firm over the next few years.
In the most recent MSFT earnings report, revenue from Azure grew 97% from the previous year and gained 4 percentage points just from the quarter before. It’s definitely a good sign for investors. However, it’s unclear just how much of Microsoft’s revenue comes from Azure, but estimates suggest it is less than 10%.
Is Office Sustainable?
Microsoft’s suite of Office programs make up 62% of the firm’s operating income. Hardware like Xbox and the surface tablets together with Azure made up the remaining 38%. So when you’re buying MSFT stock, you’re betting big on Office, at least for now.
Until Azure picks up the pace and becomes a larger part of Microsoft’s business, I don’t think we can expect to see the kind of growth that MSFT is priced for. I don’t think Office programs are going anywhere any time soon, but you might argue that many of those offerings are losing value now that mobile browsing is gaining speed.
Microsoft pays its investors a 2.15% dividend yield — unheard of in the tech space. So that’s a bonus. But still, there are a lot of cheaper dividend stocks out there if you look to other industries.
There is something to be said for Microsoft’s acquisition of business networking site Linked In. The platform helps connect professionals and organizations and will likely help the company expand its enterprise relationships, but I don’t think it’s a game changer.
Beyond perhaps helping Microsoft make connections, Linked In doesn’t contribute much to Microsoft’s bottom line. In the most recent quarter, LinkedIn had revenue of $1.1 billion, but it also cost Microsoft $1 billion to run, so the gains were minimal.
Bottom Line on MSFT Stock
Microsoft is on its way to delivering impressive growth if it can grow Azure revenue beyond the measly >10% of the firm’s overall operating income. Right now, I think MSFT stock is expensive for what it is.
Without any other compelling growth prospects, I’d only consider buying Microsoft stock if it drops below $70 per share.
As of this writing, Laura Hoy was long AMZN.