What’s the Play With Microsoft Stock Ahead of Next Week’s Earnings?

Microsoft (NASDAQ:MSFT) stock has held steady in the past few months. Shares have tread water around the $140 price level since July. Last quarter saw the company post impressive results. With the next earnings report due on Oct. 23, what’s the play with MSFT stock?

What's the Play With Microsoft Stock Ahead of Next Week's Earnings?
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Last quarter, Microsoft beat revenue estimates by $920 million ($33.7 billion quarterly revenue), and beat earnings per share (EPS) by $0.16 (EPS of $1.37). Can the trillion-dollar company continue to generate above average growth? Or will its performance come back to earth due to scale?

Let’s take a closer look and see whether earnings could drive the MSFT stock price higher (or lower).

MSFT Stock Earnings Preview

Analyst consensus is that Microsoft’s quarterly earnings will be $1.24 a share. Revenue is estimated to be $32.2 billion. Both are slight dips from last quarter (as mentioned above). But the strength of Microsoft’s Azure cloud business could help beat expectations. Nomura’s Christopher Eberle is quite bullish on MSFT stock for this very reason. He believes the company’s cloud business, which skews more toward larger enterprises, is more recession resistant than its startup-exposed peers. Eberle maintain a Buy rating on MSFT stock, with a price target of $161 per share.

Microsoft’s Cloud strengths have been underappreciated. When you think “enterprise cloud”, you probably think of Amazon’s (NASDAQ:AMZN) AWS unit. But not only is Azure Cloud a viable competitor, it may start eating AWS’s lunch. Wedbush’s Daniel Ives believes so. According to Ives, Microsoft “is poised to win the lion’s share of the next phase of cloud developments.”

Microsoft has its hand in many pots, but its focus on enterprise services is a smart move.

But how about Microsoft’s other business units? The move to the cloud has been a boon for the company’s Office 365 platform. Last quarter, Office 365 revenue grew 31%. Commercial products as a whole grew 14%. Consumer products saw slower growth (6%), but the company’s LinkedIn platform saw sales bump 25%.

Gaming has been one area of weakness. Gaming revenue fell 10% last quarter, with Xbox software/services revenue down 3%. But this is to be expected given the cyclical nature of the video game business. That cycle should swing up a year from now with the release of Xbox 2/Project Scarlett.

But is all of this already priced into the MSFT stock price? Microsoft’s recent success has pushed valuation closer to that of the FAANG stocks. Is that valuation justified?

Microsoft Stock vs. FAANGs

For years, Microsoft stock traded at a discount to the “new kids on the block” as Alphabet (NASDAQ: GOOGL), Apple (NASDAQ:AAPL), and Facebook (NASDAQ:FB) sold at substantial premiums. But that is no more. MSFT stock currently sells at a forward price/earnings (forward P/E) of 27.1. Its enterprise value/EBITDA (EV/EBITDA) is 19.

Compare this to Apple, which is priced at 20x forward earnings,and at an EV/EBITDA of 14.1x. Alphabet? GOOGL stock trades for 25.5x forward earnings, and an EBITDA multiple of 17.4x. Facebook’s valuation is 30.5x forward earnings, and an EBITDA multiple of 18.7x.

Interestingly, Microsoft’s brand value is also right up there with the FAANGs.  Interbrand’s annual Best Global Brands report ranked the brand behind MSFT stock as the world’s fourth-most-valuable, at $108.8 billion, right behind Apple, Google and Amazon. 

Microsoft’s premium valuation relative to FAANG, excluding Amazon and Netflix (NASDAQ:NFLX) could be justified. Microsoft stock has posted impressive growth figures in the past few years. Sales grew from $96.5 billion in 2017 to $125.84 billion in 2019. Diluted EPS has more surged from $3.25 a share in 2017 to $5.06 a share in 2019.

But is the growth train stalled? Can the company produce levels of growth required to sustain the MSFT stock price? We shall see on Oct. 23. If the company’s commercial cloud business continues to surge, the stock could see additional runway in the coming years.

Bottom Line on MSFT Stock: It’s All About the Cloud

Most of Microsoft’s business units are performing well. But it’s the enterprise cloud business driving MSFT stock higher. With the company eating Amazon’s lunch among large enterprise customers, Azure cloud stands to become a major force in cloud computing. Add in Microsoft’s suite of SaaS software solutions (Office 365, Dynamics 365), and it’s no wonder the stock has been the darling of Wall Street.

But at a $1 trillion valuation, how much further can the stock grow? Analysts believe the company’s revenue can continue to surge. FY2020 sales are estimated to be $140 billion, up 11% from 2019’s $125.84 billion in sales. 2021 sales could be $155.4 billion, again an 11% bump.

To be sure, 11% growth is nothing to write off. Especially for such a large company. But does this growth justify the current valuation? At 27 times forward earnings, and 19 times EBITDA, Microsoft stock may be priced for perfection.

So what’s the call? Wait for earnings to make your move. If the Street balks at Microsoft’s numbers, the MSFT stock price may take a dip. This could bring valuation to a more reasonable level. Likewise, if shares seen a slight boost, it may be worthwhile to pay a premium. If it is clear the cloud growth story is sustainable, Microsoft stock could see additional runway in the coming years.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/10/whats-the-play-msft-stock-ahead-earnings/.

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