So far, I’ve been a small brick in the “wall of worry” being climbed by Microsoft Corporation (NASDAQ:MSFT) stock. I argued in March, for instance, that Microsoft was worth about $100 billion too much. MSFT stock has gained another 12%-plus since then — and Microsoft has added around $70 billion in incremental value.
There has been some good news for Microsoft stock. But the emphasis should be on ‘some,’ and the longer-term concerns that kept a lid on MSFT stock for years aren’t gone. The company still is tremendously reliant on PC sales. Those sales have stabilized for the moment — but are highly unlikely to ever grow again.
The company’s growth drivers either cannibalize existing revenue (like Office 365) or lie in industries where Microsoft is in second place.
MSFT isn’t that expensive, admittedly, though it does trade at almost 22x fiscal year 2018 analyst earnings-per-share estimates. But that’s still a number that prices in a tremendous amount of growth. And even the recent, moderately good news doesn’t imply an acceleration for a company whose revenue grew 6% and whose non-GAAP operating income grew just 2% in a somewhat disappointing fiscal Q3.
Yet MSFT stock keeps climbing. With investors pricing in an awful lot of success, it’s getting increasingly difficult to see where further growth can come from.
Some Recent Good News for MSFT Stock
There has been some good news for Microsoft over the past few weeks. But even in that good news lies reminders that Microsoft simply isn’t the dominant force it once was.
It does appear like the WannaCry attack last month should be a plus for MSFT stock, as it could drive business users, in particular, to upgrade no-longer-supported versions of Windows. But even that modest tailwind only is a one-time boost for a business that, even as it shifts toward the cloud, is likely to be stagnant at best.
A new Surface tablet will take on the Apple Inc. (NASDAQ:AAPL) iPad. But iPad sales are in a long-term decline themselves, and Surface revenue, per Microsoft SEC filings, is a single-digit portion of overall MSFT revenue. A new Skype update mimics features offered by Snap Inc’s (NYSE:SNAP) Snapchat. But Microsoft paid $8.5 billion for Skype, which is worth a fraction of SNAP’s roughly $23 billion enterprise value — even if that valuation may be inflated at the moment.
And Microsoft’s Azure, which is such an integral part of the bull case for MSFT stock, is gaining share. A report from influential analyst Mary Meeker suggests Azure has a 34% adoption rate, up from 20% the year before. But that still puts Microsoft in second place behind Amazon.com, Inc. (NASDAQ:AMZN), whose Amazon Web Service platform is used by 57% of IT professionals.
There’s good news here — but I’m skeptical the news really is that good. And the longer-term concerns remain for Microsoft, and for MSFT stock.
Microsoft’s Second-Place Problem
At the end of the day, Microsoft remains dominant only where it has long been dominant: Windows and Office. As the company shifts usage to cloud-based versions, there are some incremental benefits to both sales and margins. But that shift is moving quickly – and will end in the not-too-distant future. (Disk-based versions of both Office and Windows seem sure to be obsolete soon enough.)
There’s competition in both spaces as well, from penetration of Alphabet Inc’s (NASDAQ:GOOG, NASDAQ:GOOGL) Android platform in smartphones, tablets and Chromebooks to Tableau Software Inc (NASDAQ:DATA) and other challengers to Office. Everywhere else, Microsoft is second place at best. Xbox One is second to the Sony Corp (ADR) (NYSE:SNE) PlayStation 4. Azure is second to Amazon. Windows Phone is a distant third. Surface is behind Apple in tablets and notebooks (though, admittedly, that gap may narrow given strong Surface reviews).
Microsoft isn’t a bad company, by any stretch. But from a competitive standpoint, it’s increasingly difficult to argue that it’s truly a great company. But the valuation of MSFT stock suggests that it is.
That’s my key concern with MSFT stock, particularly at all-time highs. The Microsoft dividend — yielding over 2.2% — helps the case. But MSFT stock increasingly is valued for years of growth. And I remain skeptical that growth indeed is on the way.
As tech stocks soar, Microsoft is going along for the ride. But it certainly looks like expectations are getting too high — and they seem to be getting higher by the day.
As of this writing, Vince Martin has no positions in any securities mentioned.
