Global technology giant Microsoft (NASDAQ:MSFT) had a really good 2019. In the year, Microsoft stock rose 55%, making it the Dow’s second-best performer of the year. That 55% gain also marks Microsoft’s best annual performance since 2009.
Will 2020 mark an extension of Microsoft’s big 2019 rally, or the end of it? The former. The reality is that Microsoft stock hasn’t had a negative year since 2011, which means that the stock has posted positive returns in every year under the leadership of visionary CEO Satya Nadella.
Why? Because of the cloud. When Nadella took over the reins in 2014, he did so with the intention of turning Microsoft into a cloud giant. He’s done just that. And, in so doing, he has guided MSFT stock to 10%-plus annual returns every year since 2014.
This dynamic will continue in 2020. That is, cloud tailwinds will remain robust, Microsoft’s competitive positioning in that market will grow more favorable, and Microsoft’s revenues, profits, and stock price will all march higher.
Valuation friction will limit MSFT stock from having another 50% up-year. But, sustained cloud tailwinds will keep Microsoft’s streak of 10%-plus up years alive. As such, investors should fully expect MSFT stock to rally another 10-15% in 2020.
Fundamental Outlook Appears Good
The fundamental outlook for Microsoft stock is quite good heading into 2020.
Front and center, Microsoft’s cloud business will accelerate in its growth trajectory next year. That’s because as trade and geopolitical tensions ease in 2020, the global economy will pick up steam, and corporations will re-accelerate spend on their cloud transformations.
Central to those cloud transformations is infrastructure, and Microsoft’s Azure is rapidly turning into the hottest and most important cloud infrastructure player in the market. Consequently, as corporate cloud spend re-accelerates in 2020, that re-accelerated spend will directly translate into revenue tailwinds for Microsoft.
But, enterprise cloud isn’t the only thing that will work for Microsoft in 2020.
Beyond the enterprise cloud, Microsoft is also set to have a huge year in its gaming segment, as cloud gaming turns into a reality with the launch of Project Scarlett and Xbox Series X. Rapid expansion of streaming game services, like Xbox Live Pass, will also boost the video game segment.
At the same time, Microsoft will launch Office 365 consumer bundles for the first time in 2020, and this should provide a healthy boost to the company’s consumer cloud business. There is also potential for Microsoft Teams (the company’s Slack (NYSE:WORK) competitor) to go from niche to mainstream into 2020, as recent data implies that Teams is already gaining significant traction.
Big picture: the fundamental backdrop for Microsoft stock will remain healthy in 2020, paced by sustained cloud market tailwinds.
Microsoft Stock Will Rise More Than 10%
The numbers are pretty easy to follow. Cloud tailwinds have propelled a steady 10% to 15% constant-currency revenue growth at Microsoft for the past few years. These cloud tailwinds will remain healthy for the next several years. Scale will provide a challenge, but, not that big of a challenge. Given that only 20% of enterprise workloads have migrated to the cloud, the opportunity is far bigger than the current base.
Thus, sustained cloud tailwinds will likely keep Microsoft’s revenue growth rates in the 8% to 12% range for the next few years.
Alongside this steady high-single-digit to low-double-digit revenue growth, gross margins will continue to improve as Azure’s profitability profile expands with increased scale. Operating expenses will likely rise at a historically normal high-single-digit pace, providing room for steady positive operating leverage. Those two dynamics should propel healthy profit margin expansion.
Putting all of this together, Microsoft reasonably projects as a ~10% revenue grower with upside margin drivers. My modeling suggests that this growth profile will produce $11.50 in earnings per share by fiscal 2026. Based on an exit multiple of 25-times forward earnings (which is about average for systems software stocks), that implies a fiscal 2025 price target for MSFT stock of nearly $290.
Discounted back by 10% per year, that equates to a 2020 price target for MSFT stock of almost $180 — and that’s more than 10% above today’s price tag.
Bottom Line on Microsoft Stock
Sustained cloud tailwinds have propelled 10%-plus annual gains in MSFT stock every year since 2014. This dynamic will continue in 2020, as IT spending trends improve and Microsoft’s revenues and profits continue to march higher at a healthy pace.
As they do, MSFT stock will rattle off another 10%-plus up year in 2020.
As of this writing, Luke Lango was long MSFT.
