Can The Cloud Push Microsoft Corporation Stock Past Decade-High Valuation?

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MSFT stock - Can The Cloud Push Microsoft Corporation Stock Past Decade-High Valuation?

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I’ve been bearish on Microsoft Corporation (NASDAQ:MSFT) ever since MSFT stock crossed into the $70 range. The shares first ventured into that territory in early July before settling into a $70-$75 range for the rest of the month.

My bearishness wasn’t a knock against a great company. I simply thought a stock trading at a decade-high valuation was due for a pullback. Yet, here we are in November, a few blowout earnings reports later, and MSFT stock price is just under $85. Clearly, I’ve been wrong so far.

The reality is that the Microsoft Azure cloud growth story has only gained momentum. Growth rates are actually going up. Gross margins are catapulting higher. The long-term profit outlook is getting stronger.

That is why MSFT stock has appreciated despite the decade-high valuation. Growth is coming up, so the valuation is also adjusting upward.

And while I continue to prefer other tech names over Microsoft because I feel they offer more bang for my buck, I also think MSFT stock will keep heading higher so long as the growth narrative remains favorable.

MSFT’s Unattractive Ratio

Microsoft isn’t the best investment in tech, but it’s still a good one.

My big problem with MSFT stock has been its valuation. The company does have solid growth prospects, but because of its already-huge revenue base, this isn’t a hyper-growth story with 20%-plus growth rates. Revenues are growing in the low double-digit range. Earnings are up in the mid-to-high teens range.

Inevitably, those growth rates will come down over the next five years. The cloud market will start maxing out. Red-hot Office 365 growth will cool down. Search ad revenue growth will moderate.

Overall, the Street is modeling for roughly 11% earnings growth over the next 5 years. I’m modeling the same. Meanwhile, MSFT stock is trading at 25x this year’s earnings. That gives MSFT stock a price-to-earnings/growth (PEG) profile of about 2.3.

That is a pretty unattractive ratio in the tech space.

Alphabet Inc (NASDAQ:GOOGL) trades trades at 32x this year’s earnings for 20% growth potential over the next five years. That gives GOOGL stock a PEG of 1.6.

Facebook Inc (NASDAQ:FB) trades at 33x this year’s earnings for 28% annualized earnings growth potential over the next five years. That gives FB stock a PEG of 1.2.

Intel Corporation (NASDAQ:INTC) is trading at 14x this year’s earnings for 9% annualized earnings growth potential over the next five years. That give INTC stock a PEG of 1.6.

Clearly, MSFT stock gives you less bang for your buck than these undervalued growth tech names.

But MSFT stock also gives you more bang for your buck than the broader market.

 

The S&P 500 Index is trading around 19.7x 2017 earnings for what is projected to be 11% growth over the next two years. That growth rate will come down in a five-year forward window. My best-guess for S&P 500 earnings growth over the same period is 7% per year. That would give the S&P 500 a PEG of 2.8.

Overall, then, MSFT stock is an okay, but not great, investment at these levels. The stock is more attractively valued than the broader market, but it’s also less attractively valued than peer growth tech names. Nonetheless, investor demand for the MSFT growth story is only growing given its accelerating nature and unparalleled stability. This will continue into the foreseeable future, meaning MSFT stock should head higher.

Bottom Line on MSFT Stock

I still think there are better places to park your money, like GOOG, INTC, and FB. Those names offer good growth at a big discount.

But MSFT stock offers decent growth at a reasonable price. There is also a level of stability that comes with owning Microsoft stock given its huge revenue base, wide reach, and diversified revenue streams. Such stability is clearly being awarded a premium valuation.

I peg MSFT’s fair value at around $90. Perhaps not coincidentally, the average price target on MSFT stock is also right around $90. I think that is where MSFT stock will head over the next 12 months, implying good (but not great) upside of about 7%.

As of this writing, Luke Lango was long GOOG, INTC, and FB. 


Article printed from InvestorPlace Media, https://investorplace.com/2017/11/how-much-higher-microsoft-msft-stock-go/.

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