Let me be clear. There is nothing wrong with Microsoft Corporation (NASDAQ:MSFT) as a company.
Management is doing all they can and more to turn MSFT into a cloud growth story. It’s working. Azure revenue is growing in the triple-digit range as the cloud computing space continues to boom. Indeed, the commercial cloud annualized revenue run rate is now close to $19 billion.
That is great news.
But there is something wrong with MSFT stock. At-best, its fairly valued.
Surprise, surprise. After more than doubling over the past 5 years, MSFT stock’s valuation has finally caught up to it. Upside from here is limited.
Lets take a deeper look at the numbers.
Microsoft Stock Is Near A Decade High Valuation
Consider this (data from YCharts):
- MSFT stock trades above 15.5-times trailing EBITDA. That is right near a decade high.
- MSFT stock trades around 6.5-times trailing sales. That is also right near a decade high.
- MSFT stock trades at 15-times trailing operating cash flow. That, too, is near a decade high.
- MSFT stock trades at more than 18.5-times trailing free cash flow. Again, that is near a decade high.
When a stock is trading near a decade high on a trailing sales, EBITDA, operating cash flow, and free cash flow basis, valuation is naturally a concern.
I fully understand that MSFT has turned into a cloud growth story, so the valuation has appropriately adjusted upward. That partially explains the decade-high valuation. But it doesn’t explain why the valuation can extend any further.
I don’t think it can. When compared against other cloud players, Microsoft looks overvalued. It becomes clear that MSFT is trading at too big of a multiple for too little growth.
For example, take Alphabet Inc (NASDAQ:GOOG). It’s trading at 23.3-times next year’s earnings estimate. That is only an 11% premium to MSFT’s one-year forward earnings multiple of 21-times. But GOOG is expected grow earnings at 19% per year over the next 5 years. That almost double the pace of MSFT’s projected earnings growth (~11%).
Or look at Oracle Corporation (NYSE:ORCL). That company has slightly lower growth projections (~9%, so about 20% lower than MSFT). But the stock also trades at 15.1-times next year’s earnings estimate. That is a 30% discount to MSFT.
This dynamic is true across the board. The cloud giants trading at more than 20-times next year’s earnings estimates (like MSFT) all have much larger growth prospects than MSFT. This group includes Alphabet, Amazon.com, Inc. (NASDAQ:AMZN), salesforce.com, inc. (NYSE:CRM), Alibaba Group Holding Ltd (NYSE:BABA), and others.
Meanwhile, the cloud players that have lower growth prospects in the single-digit to low double-digit range (like MSFT) trade at much lower multiples than MSFT. This group includes Oracle and International Business Machines Corp. (NYSE:IBM), among others.
That isn’t attractive set-up for MSFT stock. It also doesn’t help that Microsoft’s other revenue avenues are slowing down.
Surface revenues decreased 2% last quarter versus a 9% increase in the same quarter one year ago. The slowdown coincides with a pick-up in iPad sales. After 13 consecutive quarters of negative unit growth, Apple Inc. (NASDAQ:AAPL) reported that the number of iPad units shipped last quarter actually rose 15% year-over-year. That is the iPad’s first positive unit growth quarter since the first quarter of 2014.
Bing is also slowing — search advertising revenue excluding traffic acquisition costs increased 10% last quarter, versus 16% in the overlapping period one year ago. So is growth from Office 365. And growth in the Windows OEM segment.
Bottom Line on MSFT Stock
MSFT stock is trading like a hyper-growth cloud company.
But its growth trajectory implies it’s an average growth company with a hyper-growth cloud segment.
That disconnect makes MSFT a risky stock.
As of this writing, Luke Lango was long AMZN and BABA.
