Technology giant Microsoft (NASDAQ:MSFT) is set to report second-quarter earnings after the bell on Wednesday, Jan. 30. There’s reason to believe those numbers won’t be as good as expected, and that Microsoft stock will drop in response.
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In a nutshell, Microsoft is a cloud-powered company. Over the past several years, Microsoft’s multiple cloud initiatives have taken this company from flattish revenue growth to nearly 20% revenue growth last quarter. This has happened because the company’s cloud businesses (Azure, Office 365 and Dynamics 365) have remained red hot against the backdrop of ever-increasing demand.
In the long term, demand will remain robust, and Microsoft stock will head higher. But, in the near term, it increasingly appears that demand is weakening due to concerns regarding a slowing global economy. That’s bad news for Microsoft stock ahead of earnings.
As such, caution is warranted on Microsoft stock here and now. Second-quarter numbers likely won’t be as good as expected. The stock will likely fall. And the next two to three months could be choppy for MSFT.
Ultimately, this near-term turbulence will pass. Cloud demand drivers will regain their strength. Microsoft’s numbers will improve. Microsoft stock will rally back to all-time highs.
But, things will get worse before they get better. As such, near-term bearish, long-term bullish seems to be the best stance on Microsoft stock at the moment.
Long-Term Outlook Remains Healthy
The long-term fundamentals supporting MSFT stock remain healthy in a multi-year window.
The entire growth narrative at Microsoft is powered by the cloud. Ever since Satya Nadella took over the reigns in 2014, Microsoft has become a cloud-first company. Solutions like Azure, Office 365 and Dynamics 365 were born. They turned into huge growth drivers. Ever since, Azure has largely remained a 75%-plus growth business. Officer 365 has been a 35%-plus growth business. Dynamics 365 has been a 50%-plus growth business.
Putting that all together, under Nadella’s cloud-focused leadership, Microsoft has gone from a flat revenue growth company to a 20% revenue growth company.
This renewed growth is here to stay for a lot longer. Only about 20% of enterprise workloads have migrated to the cloud. That’s a low number. Enterprise cloud solutions offer price, convenience, and efficiency advantages over their on-site comps. As such, the consensus belief is that the 20% number will inevitably rise to 100% in the long run.
From this perspective, the world is only about one-fifth of the way through the cloud revolution, implying big growth for a lot longer. That’s why most industry analysts and research firms peg this as a 20% to 30% (or bigger) growth market over the next several years. Microsoft is at the head of this market, second only to Amazon (NASDAQ:AMZN), and is rapidly growing shares. As such, Microsoft’s long-term cloud growth drivers have tons of firepower over the next several years.
More than that, Microsoft stock is supported by stable financials. The balance sheet is clean, with a huge net cash position of over $50 billion. There’s a healthy 1.6% dividend yield, supported by $45 billion in operating cash flow over the past twelve months. Capex rates are contained. The free cash flow yield is around 4%. The valuation is among the lowest in the big tech / AI group.
Overall, MSFT stock looks good for the long haul. The cloud will continue to power big growth over the next several years, and those big growth rates will converge on rock-solid financials and a reasonable valuation to push MSFT stock higher.
Near-Term Demand Issues Are a Headwind
Although Microsoft stock looks good for the long haul, there are near-term headwinds that will keep this stock depressed for the foreseeable future.
Namely, the cloud market’s biggest suppliers — chipmakers Intel (NASDAQ:INTC) and Nvidia (NASDAQ:NVDA) — have recently fired warning shots about slowing demand in the global cloud market. Both of them essentially said that increasing macroeconomic uncertainty has caused the red-hot cloud market to cool off. Cloud customers are holding back orders. Neither chipmaker is sure when this slowdown will end. As such, both cut guides and sounded a bearish tone regarding cloud growth over the next few quarters.
MSFT is a big customer for both Intel and Nvidia. If both Intel and Nvidia are saying the cloud market is slowing, that’s bad news for Microsoft stock, and it implies Microsoft’s second-quarter numbers will be worse than expected.
Worse yet, Microsoft stock trades at a significantly above-average 24 forward earnings multiple due to investor optimism surrounding the company’s cloud businesses. If second-quarter numbers show weakness in those businesses, that optimism could quickly retreat. If it does, Microsoft stock’s multiple has room to fall, implying material near-term downside risk for Microsoft stock.
Overall, MSFT stock does not look good in the near term. It increasingly appears that the global cloud market is slowing, and that will ultimately show up in Microsoft’s numbers. When it does, MSFT stock will fall, due to its relative overvaluation.
Bottom Line on MSFT Stock
Long term, Microsoft stock is a winner. But, in the near term, there’s reason to be cautious on the name amid a material slowdown in the global cloud market. So long as this slowdown persists, Microsoft stock will struggle for gains.
As of this writing, Luke Lango was long AMZN and INTC.
