Microsoft (NASDAQ:MSFT) stock has surged 47% in 2019 and is near its all-time high. Pretty much everyone on Wall Street thinks that the record rally of MSFT stock will continue. According to TipRanks, all 26 Wall Street analysts who cover Microsoft stock have a “Buy” rating on the shares, and their average price target is about $160.
Normally, I’d say that such overwhelmingly upbeat sentiment is too bullish. MSFT is a red-hot tech stock, up nearly 50% so far this year and at all-time highs. Every analyst has a “Buy” rating on MSFT stock and expects MSFT stock price to climb further in 2020, In order for me to believe in the analysts’ outlook, I have to believe that the company’s underlying business is firing on all cylinders.
But that’s exactly what I believe. Its business is firing on all cylinders today, with all of the important trends affecting the company improving into 2020. At the same time, the valuation of MSFT stock is stretched, but not high enough to offset the tremendous momentum of its business.
All together, Microsoft stock looks positioned to keep making new highs over the next few months.
Microsoft Is Firing on All Cylinders
Thanks to multiple favorable developments over the past few months, every facet of Microsoft’s business is performing very well, and that trend looks poised to continue.
Meanwhile, macroeconomic trends are improving, as easing U.S.-China trade tensions are restoring companies’ confidence. This renewed confidence will spark a rebound of capital spending trends, and that means companies around the world will start to invest more aggressively in cloud infrastructure migrations in 2020. As a result, Microsoft’s market-leading cloud infrastructure business will get a boost.
At the same time, Microsoft recently beat out Amazon (NASDAQ:AMZN) for the Pentagon’s highly coveted JEDI cloud contract, representing a pivotal moment in the cloud sector. Specifically, the win signals that Microsoft might be the new king of the cloud market.
Other companies have taken note of this. Since Microsoft won the JEDI contract, it has scored cloud contract deals with Baker Hughes (NYSE:BKR), ACI Worldwide (NASDAQ:ACIW), Salesforce (NYSE:CRM), and Nokia (NYSE:NOK). MSFT will have more cloud contract wins over the next few quarters as companies increasingly gravitate towards Microsoft. All of these contract wins will tremendously lift Microsoft’s overall growth.
Further, the video game market is set to improve massively in 2020, thanks to the spread of cloud gaming and new console launches. Finally, the Internet-of-Things market will get a big boost in 2020 thanks to the deployment of 5G.
Microsoft Stock Can and Will Head Higher
Given Microsoft’s operational momentum, MSFT stock price can and will head higher.
The forward P/E ratio of MSFT stock, based on analysts’ average 2020 earnings per share estimate, is 24.7. That’s well above the stock’s average historical forward earnings multiple of 21.
But the shares’ valuation premium is warranted by the company’s faster growth. MSFT’s average revenue growth rate from 2013 to 2018 was around 6%. In 2019, its revenue growth was 15%. In 2020 and 2021, its top-line growth is projected to be north of 10%. From 2013 to 2018, its profit margins dropped. Now they are expanding.
In other words, as Microsoft’s growth has accelerated, the multiple of MSFT stock has expanded. That definitely makes sense.
Can the P/E multiple of MSFT stock keep moving higher? Yes. For the most part, MSFT stock is cheaper than any other cloud stock. Other large-cap cloud stocks — think Adobe (NASDAQ:ADBE), Salesforce, or Amazon — trade north of 40-times average forward EPS estimates.
As long as the valuation of MSFT stock remains relatively attractive and the momentum of the company’s business remains healthy, MSFT stock price will keep moving higher, powered by gradual multiple expansion and healthy profit growth.
The Bottom Line on MSFT Stock
Microsoft stock looks great heading into 2020. MSFT’s business is firing on all cylinders, and its profits should soar higher. At the same time, its valuation remains reasonable, and there’s still room for slight margin expansion.
When stocks’ multiples and profits go higher at the same time, they climb twice as quickly. That’s why MSFT stock will keep making new highs.
As of this writing, Luke Lango was long MSFT and ADBE.
