A challenging task for analysts would be to provide negative coverage on the business of Microsoft Corporation (NASDAQ:MSFT). The company has a strong clientele, stable cash flows and a high-growth business in the form of Microsoft Azure. However, with the stock having moved higher by 45% in the past year, there can be concerns on MSFT stock valuation.
I believe that even valuation is not a concern and the MSFT stock price can continue to trend higher. While Amazon (NASDAQ:AMZN) is not a direct peer, valuations can be compared with both companies having a growing cloud business.
Microsoft stock trades at a forward price-to-earnings ratio of 27.97 and Amazon trades at a forward P/E of 65.75. This, however, does not provide a complete picture on the valuation since Amazon is on a higher growth trajectory. It, therefore, makes sense to consider the price-earnings-to-growth ratio (PEG) and Microsoft trades at a 12-month forward PEG of 2.35. On the other hand, Amazon trades at a 12-month forward PEG of 3.1.
So Amazon stock does look relatively expensive and I see more juice in the rally for MSFT stock. Further, MSFT returned $7.9 billion to shareholders in the first quarter of 2020 through dividends and share repurchase. With an annualized shareholder value creation of $31.6 billion, MSFT stock does deserve a valuation premium.
Cloud Business Remains a Growth Driver
For 1Q20, the company’s revenue from “Intelligent Cloud” segment was $10.8 billion, which was higher by 27% on a year-over-year basis. The cloud business is likely to remain the key growth driver for MSFT.
While Amazon Web Services remains the most popular cloud service platform, “Microsoft Azure is gaining ground quickly in application workload.”
An important point to note is that businesses prefer partnership with more than one cloud provider (multi-cloud strategy). This expands the potential market for top players in the industry. According to a Gartner survey, 81% of respondents said they are working with two or more providers.
International Business Machines (NYSE:IBM) has been a laggard when it comes to making inroads in the cloud business. However, with the acquisition of Red Hat, the company is hopeful of gaining market share because of the multi-cloud strategy.
New Product Line-Up for Surface
For 1Q20, Microsoft reported revenue of $11.1 billion from the “Personal Computing” business segment. Revenue increased by 4% YoY, but Surface revenue decreased 4%.
I believe this is likely to change in 2020 and Surface can contribute to revenue growth in the business segment. In October, Microsoft revealed the “broadest Surface line-up ever.” This includes five products to be launched in 2019 and two new products to be launched in 2020.
Talking about new products, Microsoft Teams has reached 20 million daily active users as compared to 13 million DAUS in July. Slack Technologies (NYSE:WORK) stock declined on this news with Microsoft having a clear edge.
As Dan Ives of Wedbush writes in his note on Slack: “Microsoft represents the biggest risk for investors given its massive enterprise installed base and the fact that it offers Teams with no extra charge to its Office 365 business customers.”
I wanted to mention this here to underscore the following point: With a large customer base, Microsoft can make any new product big. This particularly holds true for the “commercial products” segment.
Final Thoughts on MSFT Stock
The cloud segment will remain the key growth driver even as Microsoft Azure growth decelerates on a relative basis. At the same time, Microsoft is focused on new product launches, which can trigger incremental growth.
It is worth noting that Microsoft has also been making significant investments related to research in artificial intelligence. Recently, Baker Hughes (NYSE:BKR) announced a partnership with C3.ai, and Microsoft to bring enterprise AI solutions to the energy industry on Microsoft Azure. Investment in AI research will help in driving growth in the cloud business.
In conclusion, MSFT stock remains attractive even after the upside in the last one year. The company should continue to report healthy growth and that will help the stock remain in an uptrend.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
