Microsoft (NASDAQ:MSFT) has experienced an amazing comeback. Just a few short years ago, the company found itself falling behind as its core PC business had fallen out of favor. Under the leadership of CEO Satya Nadella, the company reinvented itself. This has sent Microsoft stock to new highs.
Unfortunately for new investors, this comeback has made MSFT stock expensive.
While Microsoft will continue to maintain one of the strongest balance sheets in American industry, investors should avoid Microsoft stock for these four reasons:
Reasons to Sell Microsoft Stock:
The Price-Earnings Ratio
MSFT stock trades at a forward price-to-earnings ratio of 25.1, assuming current earnings estimates hold. By many measures, this multiple does not look horrible. It does not approach the triple-digit P/E seen in Amazon (NASDAQ:AMZN). It also remains close to the average P/E for the S&P 500.
However, this P/E spiked to over 50 this year. This marks a dramatic departure from recent years. For most of the time since the 2008 financial crisis, Microsoft stock’s P/E has remained in the teens.
Analysts expect profit growth of 14.7% this year and an average of 12.4% in subsequent years. This takes the forward price-to-earnings-to-growth ratio to 1.7. It also stands well above the current S&P 500 PEG of 1 and the long-term average PEG of 1.33.
This happened because bargain hunters came in and bid up the value of Microsoft stock. As a result, Microsoft’s value has nearly tripled since Nadella took over in Feb. 2014. Such a move stands as a credit to Nadella’s leadership. Unfortunately, it also leaves few options for buyers to get into Microsoft stock at a low price.
Reasons to Sell Microsoft Stock:
The Influence of Windows and Office Lingers
Despite Microsoft’s current focus on the Azure cloud platform, its PC-related segments still account for most of the company’s revenue. The company’s Productivity and Business Processes division grew 10% year-over-year in the latest quarter. Microsoft Office makes up most of this division, and it grew by single digits. It took LinkedIn’s 34% growth to bring overall growth in this division to 10%.
Although Windows fared better, the division, which includes Windows, More Personal Computing, saw its most significant growth with gaming. The division grew by 16% overall. Windows commercial products increased by 19%. However, gaming and Xbox segments saw more than 30% year-over-year growth.
Windows likely benefitted from a partial comeback in PC sales. However, the company suffered for years as more people turned away from PCs and opted for smartphones and tablets. These ran not on Windows, but on Android or iOS, which archrival Apple (NASDAQ:AAPL) produces. Even if Windows and Office continue to grow, they now face competition that did not exist in the last century. Hence, its largest segments will remain Microsoft’s slowest growth segments in the near-term.
Reasons to Sell Microsoft Stock:
Azure Affirms Its Status as Old Tech
The choice of Satya Nadella as CEO has changed the focus of the company. Nadella’s Microsoft shifted the company’s focus to the cloud. Intelligent Cloud has become the fastest-growing division in the company as it grew by 20% year-over-year. Within that division, Azure has enjoyed a great deal of success. Azure usage increased by 85% over the same period. It stands second only to Amazon’s AWS regarding market share.
Still, unlike Windows and Office in the twentieth century, Azure will never enjoy monopoly power. Rather than forming monopolies, Microsoft’s future will depend on adapting to ever-changing tech trends. IBM (NYSE:IBM) and Texas Instruments (NASDAQ:TXN) have remained relevant for decades with the same approach. Microsoft will likely follow this example. But that’s the thing. Instead of remaining new tech, MSFT has become the new IBM.
Constant adaptation has served old tech companies well for decades. However, instead of serving as the innovator, MSFT stock is behind a company that changes with the times but ceases to lead the change.
Reasons to Sell Microsoft Stock:
Large Market Cap
Another issue relates to the company’s size. As a successful old tech company, MSFT has become both blessed and cursed with a large market cap. To be sure, going from a concept created by two high school friends to an $823 billion company stands as an impressive feat by any measure. Through the years, Microsoft has brought personal computing to billions of people and made many early investors in MSFT stock very wealthy.
However, becoming that large means that the laws of mathematics will limit MSFT stock. If one buys stock in this $823 billion company, MSFT will have to grow into a $1.64 trillion firm for that stockholder to double his money one time. It will have to reach almost $3.3 trillion to double twice. So far, only Apple has moved past the $1 trillion mark.
In time, stocks will surpass the $2 trillion and the $3 trillion milestones. Still, when a stock has to break records to double one time, it becomes likely growth will slow substantially. The current 1.5% dividend yield will likely not compensate. At a lower multiple, Microsoft stock will serve as a fine choice to preserve wealth. Still, if one wants future stock appreciation, prospective buyers should search for companies with a market cap of $823 million, not $823 billion.
The Bottom Line on MSFT Stock
Ironically, the fact that Microsoft has become one of the most successful companies in American history makes MSFT stock a sell. Its success has driven its P/E ratio to highs not seen in decades. Legacy products such as Windows and Office have seen a partial comeback. Although PCs will not go away, they have increasingly become niche devices. Since Microsoft serves as a minor player in the smartphone and tablet markets, this continues to hurt the company.
Microsoft’s cloud product Azure drives the company now. Azure will continue to prosper for the foreseeable future. Still, it has confirmed Microsoft’s status as an old tech company like IBM. The company will use its resources to stay relevant, but it will probably become a follower rather than a leader in the tech sector.
Moreover, the growth from its 40-plus years in existence has taken Microsoft stock to new highs. While that made long-time holders wealthy, its days of generating out-sized returns have likely come to an end.
Investors wanting to preserve wealth should consider buying MSFT stock if the P/E comes down. However, at these levels, Microsoft stands as a great company supporting an overpriced stock destined for slow growth.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
