Microsoft Corporation (NASDAQ:MSFT) has surprised its fans since its recent earnings announcement. Despite delivering what appeared to be blowout numbers, MSFT stock only rallied slightly on the news. By the next day, shares had turned lower, and have failed to make any subsequent progress.
What’s holding Microsoft stock back? Is there something hidden in the numbers? Is it a victim of the general concerns starting to hit tech stocks? Perhaps investors are becoming concerned with the stock’s high valuation.
Regardless of the reason, can MSFT stock get back to rallying? Or should investors be selling? Let’s take a look at the pros and cons.
MSFT Stock Cons
Tech Sector Troubles: The tech sector may be entering a correction. The PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ), which represents the NASDAQ 100 index, is up more than 21% year-to-date. That’s a huge run. Some profit-taking shouldn’t surprise investors.
Earnings season may be the catalyst to trigger selling. Even companies with strong results, such as Microsoft, have seen their shares stagnate. Meanwhile, the market has punished companies such as Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) that delivered decent results for not quite being good enough. Stocks don’t go straight up forever. Tech in particular is in for a round of profit-taking, and MSFT stock is unlikely to have immunity. July 27 served as a warning; Microsoft stock dipped as much as 3% within a couple of hours as tech stocks slumped.
Up Too Much Already? MSFT stock has delivered tremendous results in recent years. The stock is up from $40 in 2015, the mid-$50s last year, and $65 last quarter. Just this month, Microsoft moved up from $68 to $74.
Even tremendous earnings results might not be enough to add much to the company’s gains. Despite the fast-growing cloud division, Microsoft is still a lumbering company at its core. Its value can’t double or triple virtually overnight like some more nimble high-fliers. Investors must exercise patience with blue chip stocks, they tend to rally at a more measured pace.
Looks Expensive: Historically, Microsoft has traded fairly cheaply. Its median price-to-earnings ratio over the past 10 years is just 16x. Today, we’re at 32x. To be clear, Microsoft’s outlook has greatly improved over the past few years.
That said, 32x might be a bridge too far. Again, Microsoft isn’t a revolutionary company like, say, Nvidia Corporation (NASDAQ:NVDA). Microsoft’s cloud business is great, but the bread and butter business is still Windows and Office, neither of which have huge growth prospects. There is a limit to how much investors will bid that type of cash flow up. Additionally, MSFT stock’s dividend yield has slid to just 2.2%, reducing the company’s appeal to blue-chip income investors.
MSFT Stock Pros
Azure’s Dominant Performance: Microsoft has recently prioritized its intelligent cloud business, while laying off workers and diverting resources from elsewhere. This strategic shift, though risky, continues to bear fruit.
The pivotal Azure division put up an astonishing 93% year-over-year growth rate, driven by gains in computing and premium services. Azure’s year-over-year growth rate is actually picking up steam, despite its increasingly large starting base. Overall, the intelligent cloud operations earned $6.8 billion in revenues on the quarter. That puts it well on its way to hitting the $20 billion annual run rate by 2018 that Microsoft has targeted. After years of uninspiring leadership under Steve Ballmer, Microsoft’s current CEO, Satya Nadella, appears to have the company moving toward more profitable markets.
Amazon’s Pain, Microsoft’s Gain: Microsoft’s Azure results continue to impress. And they may be hitting their most important competitor where it hurts. On Thursday, Amazon.com, Inc. (NASDAQ:AMZN) stock shed 4% of its value on a soft earnings report.
While some of that loss was likely triggered by less-than-stellar Prime Day results, Amazon Web Services also showed cracks. AWS segment revenue rose 42% year-over-year, but its operating income only climbed 28%. AWS’ margins are falling rather significantly. Meanwhile, Microsoft is reporting record strong results and encouraging forward guidance.
Amazon may well be invincible as a retailer. Within computing, however, strong competitors including Microsoft have the financial and technological firepower to potentially win the war. Should AMZN stock continue to slide, Microsoft could rally further on a rotational trade. Azure profits do much more for Microsoft’s stock price than its legacy Windows and Office results. Beating Amazon in the cloud battle is the fastest way to a sharply rising MSFT stock price.
Analyst Upgrades: While investors haven’t raised their bids for MSFT stock yet, analysts are raising their price targets following the earnings report. Cowen’s Gregg Moskowitz maintained his outperform rating on Microsoft and bumped his price target to $80.
Meanwhile, Stifel came in with an even stronger statement. Their analyst, Brad Reback, calls MSFT stock a buy, and raised his target by $7 to match Cowen at $80. Reback is optimistic on Microsoft’s margins and commercial cloud revenues.
Verdict
Frankly, investors are right to feel a little disappointed with the market’s reaction to Microsoft’s recent earnings announcement. The company is firing on all cylinders, and yet the stock has sold off slightly over the past week.
The bears will argue that Microsoft is overvalued, and thus even an earnings beat can’t justify a higher stock price. However, compared with the FAANG stocks, you can make a decent case for going long MSFT here, even after its big run. A move toward $100 could well be in the cards as long as Microsoft continues to show growing competitiveness against Amazon’s AWS.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
