Since 2013, nothing has slowed Microsoft (NASDAQ:MSFT) stock. The MSFT stock price has risen more than 400% over that stretch. The company itself hasn’t stumbled at all. In fact, the only two significant declines of MSFT stock came amid market-wide pullbacks in early 2016 and late 2018.
Both declines of MSFT stock price, obviously, proved to be buying opportunities. But the question at the moment, with MSFT stock now rangebound for almost four months, is if it’s likely to climb further. Microsoft stock, after all, is the most valuable name in the world at the moment. Presumably, the easy money has been made.
And I’ve tended to be bearish on MSFT. I did finally come around last year, but I thought this summer that the “trillion-dollar curse” might hold. Like every other skeptical view of MSFT stock over the past seven years, it proved wrong
Looking forward, with MSFT’s fiscal first quarter earnings two weeks away, the question now becomes not what will go right, but what can go wrong. Again, this is the world’s most valuable company. And MSFT’s massive base of now-recurring revenue gives Microsoft stock some defensive qualities as well. The bull case on the shares is well-known and widely covered.
The reasons why Microsoft stock could continue its run are obvious. But the risks facing MSFT are worth understanding. Because if, as has been the case for years now, those risks don’t play out, there’s little to stand in the way of further increases of MSFT stock price.
Azure and MSFT Stock
Microsoft’s Azure cloud computing unit has been a key factor behind the recent gains of MSFT stock. The unit’s growth has been phenomenal; according to Microsoft’s filings, its revenue increased 91% in fiscal 2018 and another 72% in FY19.
Microsoft still hasn’t broken out the exact total of Azure’s revenue, but many analysts think that the unit’s annual sales are in the $13 billion range. If that’s the case, Azure’s sales increased more than $5 billion in fiscal 2019, driving one-third of MSFT’s total revenue growth.
Azure’s growth is going to slow simply due to the increasing size of the business. Indeed, in Q4, its revenue rose 64% year-over-year, decelerating from the first three quarters of the year, when its top line grew well above 70%. But the growing size of the business means its smaller percentage increases can have a bigger effect on the company’s overall top line.
But that growth needs to continue amid steep competition. Amazon (NASDAQ:AMZN) is the undisputed leader of the cloud sector. Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) is trying to gain share in the sector. The latter stock was recently upgraded by Deutsche Bank last week on the momentum of its cloud business. Oracle (NYSE:ORCL) and IBM (NYSE:IBM) are playing catch-up as well.
The analyst who’s most bearish on MSFT stock has said that Azure’s margins could drop. Jefferies analyst John DiFucci argued that Amazon would cause the cloud sector’s margins to decline,,just as it has in retail. With so little detail from Microsoft on Azure, it’s hard to disprove that thesis at the moment.
Jefferies isn’t necessarily right. Most investors and analysts are betting that Azure’s impressive growth will continue for years. But that very fact shows how important Azure is to Microsoft stock. Azure accounts for a big percentage of MSFT’s growth and a large part of the bull case on MSFT stock. Microsoft will need to compete effectively against its rivals to keep its growth and the bull case on MSFT stock intact.
Fundamentally, the question might be whether Microsoft stock can get a much higher earnings multiple than it does right now. Analysts’ average FY20 consensus EPS estimate for MSFT is $5.24. Even excluding the company’s roughly $8 per share of net cash, that suggests Microsoft stock is trading at a forward price-earnings ratio of over 24.
That’s a big multiple, and it’s worth remembering that MSFT traded at less than half that ratio earlier this decade. Obviously, MSFT has improved a great deal since then. But the worry is that the multiple of MSFT stock may not climb much further.
Other large-cap tech plays, like GOOG and Facebook (NASDAQ:FB), are much cheaper than Microsoft stock. Both companies have larger risks, including regulatory issues. But the near-term growth outlook of those stocks generally are more attractive than that of MSFT.
I’m not yet worried about the valuation of MSFT stock, particularly with the company reporting sustainable double-digit-percentage EPS growth. But if MSFT stumbles, its valuation could become a modest problem. If Azure’s growth slows, long-term earnings growth expectations may fall from 10%+ to something closer to the high-single digits. That would make MSFT’s forward multiples higher and scare some investors. As a result, MSFT stock price could fall meaningfully.
Microsoft Stock and the Market
Azure seems to be the biggest potential long-term risk to Microsoft stock. But as Amazon expands its reach, more and more companies may not want to do business with its cloud unit. Will one of AMZN’s streaming video competitors like Disney (NYSE:DIS), or a grocer like Kroger (NYSE:KR) which is being hurt by AMZN or a retailer of any kind want to support a rival? As a result, Microsoft could well pick up business from the ever-lengthening list of Amazon competitors.
In other areas, the case for MSFT stock appears relatively stable. Office 365 is dominant. Windows isn’t going anywhere. Its hardware efforts have had some success, although they aren’t large enough to move the needle on MSFT stock.
History has shown one risk facing MSFT is the market as a whole. Again, MSFT stock price has pulled back when the market has, most notably late last year. At one point, Microsoft stock had fallen 20% in less than three months.
And MSFT will continue to be linked to the market. For MSFT, one of the perks of being the world’s most valuable company is that ETFs own large amounts of its shares. But that’s only a perk when the amount of money invested in U.S. equities is increasing. If its decreasing, Microsoft stock will pull back.
The beginning of Q4 2019 looks an awful lot like the Q4 of 2018. Last year, we learned that MSFT isn’t necessarily a “safe” place to hide out. If the market falls, MSFT stock price likely will, too.
So should investors sell Microsoft stock right now? Probably not, as trying to time the market generally is a fool’s errand. But for those of us who don’t own MSFT, its problems may produce a better entry point. Over the long-term, however, seemingly, there doesn’t seem to be much that can take MSFT stock price down.
As of this writing, Vince Martin has no positions in any securities mentioned.