Microsoft Stock Is Fairly Valued, but Azure’s Success Will Drive It Higher

This continues to be a solid year for Microsoft (NASDAQ:MSFT). Shares are up 51% year-to-date. In the past month alone, Microsoft stock jumped from $138.45 at the open Oct. 21 to $150.39 at the close Nov.19, primarily due to the success of its Azure cloud computing business.

Microsoft Stock Is Fairly Valued, but Azure's Success Will Drive It Higher

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But is there more runway in store for Microsoft stock? The cloud party has just started. With decent performance from Microsoft’s other businesses, the company could generate additional upside for investors.

Valuation is high, but the company’s growth prospects may justify the current MSFT stock price. Let’s take a closer look, and see why shares may be an opportunity today.

Across the Board Growth for Microsoft Stock

The move to cloud computing is a game-changer for big tech. Amazon’s (NASDAQ:AMZN) AWS unit may be the biggest cloud purveyor, but Microsoft’s Azure is catching up. Azure is a key catalyst for the MSFT stock price.

Stifel Nicolaus’s Brad Reback believes Azure will be Microsoft’s biggest business by 2023. The cloud business currently generates $17 billion a year for Microsoft. But that’s just the beginning.

Cloud computing has only reached 10% penetration. As more large enterprises move to the cloud, Microsoft stock could win big thanks to large increases in revenue.

Reback projects Azure could grow to $35.2 billion in revenue by FY 2022 (year ending June 2022). But the growth doesn’t stop there. Reback projects a staggering $90 billion in cloud revenue for MSFT stock by 2030.

But how about Microsoft’s other businesses? Based on the latest earnings release for Microsoft stock, the other units are largely seeing impressive growth. For the quarter ending Sept. 30, Microsoft saw a revenue increase of 14% year-over-year. Operating income grew 27% YoY. Earnings per share were $1.38, a 21% bump from the prior year’s quarter.

Microsoft’s Productivity and Business Processes unit (Office 365, LinkedIn, Dynamics) grew 13% YoY. Office 365 (commercial revenue growth of 25%) was a key driver.

LinkedIn saw revenues soar 25% as well. Thanks to Azure’s 59% growth, the Intelligent Cloud segment grew 27%. The one lagging unit (relatively) for Microsoft stock was the More Personal Computing segment (4% YoY growth). This unit includes Search Advertising, Surface, and Xbox.

But overall, Microsoft stock is benefiting from growth across its businesses, not only from Azure. Is this growth already priced in? Let’s take a look at valuation.

Microsoft Stock Sells at a Fair Valuation

Relative to peers, MSFT stock is fairly priced. The company’s forward price-to-earnings ratio (forward P/E) is 28. Its trailing twelve-month (TTM) Enterprise Value/EBITDA ratio (EV/EBITDA) is 19.1. Similarly, competitor Alphabet (NASDAQ:GOOG GOOGL), trades around the same multiples (28.5 times forward earnings, EV/EBITDA ratio of 18.2).

In contrast, Amazon trades at a higher valuation. AMZN trades for 85.2 times forward earnings, and has an EV/EBITDA ratio of 26.3. Could Microsoft’s valuation reach levels seen by Amazon? Likely not, given AMZN continues to grow at rates well above 20%/year. But Microsoft’s growth is impressive, even if the current MSFT stock price reflects said growth.

Multiple expansion may not be in the cards for MSFT stock. But the company could see additional big gains thanks to Azure. The cloud unit is quickly catching up to AWS.

As InvestorPlace’s Vince Martin wrote on November 14, AWS will generate $30 billion in the calendar year 2019, compared to Azure’s $20 billion in sales for FY 2020. But given the impressive growth figures as of late, Azure could soon be a nose away from being number one.

Becoming a larger cloud provider than AWS could help accelerate growth. More and more corporate clients could decide to follow the crowd and choose Azure for their cloud. Enterprises choosing the cloud can also help solidify sales of Microsoft’s other enterprise offerings such as Office 365 and Dynamics.

Put together, Microsoft could continue to grow at the same levels as present. While shares may not climb another 50% next year, the MSFT stock price could see decent returns in 2020.

The Bottom Line on Microsoft Stock

Investors buying at today’s MSFT stock price likely won’t see the big gains of years past. But there’s still upside left on the table for those considering the stock today. If Microsoft continues to see solid revenue growth, shares should follow along with it.

There are a few risks. If Azure growth starts to slow, investors may not continue to give Microsoft stock such a high valuation. It may not fall to the valuation levels of Oracle (NYSE:ORCL) and IBM (NYSE:IBM), but its valuation on par with Alphabet may vanish. The competition could also get tougher with AWS; expect the two “cloud kings” to fight toe-to-toe for the biggest piece of the enterprise cloud pie.

Compared to other opportunities, Microsoft stock is a solid play. Consider the risks and valuation, but there may be more upside in the near-term.

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

Article printed from InvestorPlace Media,

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