Is Microsoft Stock Price Too Much of a Good Thing?
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Is Microsoft Stock Price Too Much of a Good Thing?


The Microsoft stock price has surged over
200% in the last five years but are shares about to go a little soft? In this video, I’ll break down that massive
return and give you a full analysis including the Microsoft stock news that could move the
market. We’re talking investing in Microsoft today
on Let’s Talk Money! Beat debt. Make money. Make your money work for you. Creating the financial future you deserve. Let’s Talk Money! Joseph Hogue with the Let’s Talk Money channel
here on YouTube. I want to send a special shout out to everyone
in the community, thank you for taking a little of your time to be here today. If you’re not part of the community yet,
just click that little red subscribe button. It’s free and you’ll never miss an episode. The stars have aligned for Microsoft lately
and shares have produced a 27% annualized return in the last five years. That’s almost triple the 9.3% annual return
on the broader market. In fact, even against some of these big growth
names, Microsoft has outperformed. It’s beaten the big FANG stocks like Facebook
and Apple over that five-year period. In fact, only Netflix has produced a higher
return and I’ll be doing a full analysis of that stock in our next video so don’t
miss that one. But is it too much of a good thing? Can Microsoft keep up that pace? One analyst has a $163 price target for 17%
upside over the next year while another has the shares at just $93 each or a potentially
devastating 33% downside…so which is right? Let’s look at what those analysts are watching,
what matters most in Microsoft’s stock price and develop a stock price target of our own. First though, if there’s a company you want
to see analyzed, let me know in the comments below and I’ll put something together. Shares of Microsoft have been on fire with
growth in its cloud business. That 27% annual return over the last five
years would be impressive for any company but it’s absolutely amazing considering
the sheer size of Microsoft. This is a trillion-dollar company growing
revenue and earnings at 10% a year! Now one casualty of this huge growth has been
the dividend yield. I’ll get into the cash return numbers but
even on solid dividend growth, the payout hasn’t been able to keep up with the stock
price. Remember that the dividend yield is just the
dividend divided by the stock price so even if the dividend is increased, you can still
be getting a lower return if the shares increase faster. Microsoft has increased its dividend but the
share price has grown so much faster that the company is only paying a 1.3% dividend
yield versus a 2.5% yield in 2014. So Microsoft doesn’t qualify for our 2019
Dividend Portfolio because it fails that 3% yield requirement but a total return of almost
30% a year would put the company on anyone’s radar. Right now, shares are trading at 29-times
the company’s earnings. That’s pretty lofty considering competitors
like Cisco trade and the industry itself trades around 20-times last year’s earnings. Looking at this graphic on Microsoft’s price-to-earnings
history, the valuation on shares has contributed to about half the overall stock price increase. We’ll look at the company’s earnings growth
but think about what I just said. The price-to-earnings ratio represents investor
enthusiasm, how much investors are willing to pay for a company’s earnings, and that
increase in sentiment has contributed to half of Microsoft’s stock price increase. As we’re looking through the company’s
business growth, you’ll see that a lot of that positive sentiment is deserved. Microsoft has really been firing on all cylinders
in a lot of its business segments but whenever you have a big chunk of a stock’s return
depending on that investor sentiment, the PE ratio, it gets very hard to keep that up. Earnings are expected higher by 9.9% over
the next year to $5.22 per share and you can see that management has done a good job of
beating expectations. That 13% earnings surprise last quarter was
just over the average with Microsoft beating earnings estimates by about 11% on average
over the last two years. Sales are expected 9.8% higher to $138.2 billion
over the next year and this is really where I think we could see the company continue
that strong earnings performance. Not only is Microsoft growing sales at a very
strong clip but it’s improving profitability as well and spinning off a huge amount of
cash flow. So current expectations are for sales and
earnings to grow at that same 10% rate but if Microsoft is becoming more profitable,
it should be able to grow earnings faster than sales. We’re here in the company’s income statement,
the financial statement showing its sales and earnings and remember you want to look
at the company’s operating income. I pointed this out a few weeks ago as one
of the most important measures to compare stocks, taking that operating income against
the revenue to find the company’s profitability compared to peers. Here we see that Microsoft made just over
$35 billion last year in operating profits against $110 billion in sales. That’s an operating margin of 32% which
is a huge improvement over the 25% margin it reported in 2017. By comparison, Cisco is reporting a 26% operating
margin so not only is Microsoft above its peers in this business profitability measure
but its improving on that profitability as well. That boost to earnings from profitability
plus a share buyback program should make it easy to beat these earnings numbers and I’m
expecting profits closer to $5.70 a share over the next year. Now let’s look at where those sales and
earnings are coming from and how Microsoft has been able to grow that stock price by
27% annually. Last quarter’s Azure sales, that’s the
company’s cloud services, surprised to the upside with a 64% year-over-year growth and
this is really the driver over the last few years. Microsoft announced its largest cloud services
deal ever with a $2 billion contract with AT&T and CEO Nadella said there is a line
of sight to many more such deals. Server products continue to do well and the
key is that margins, or that profitability is improving so even as the company books
solid growth, it’s doing it more efficiently as well. Microsoft has successfully transitioned from
that point-in-time sales model to a subscription service and is positioned for the cloud-based
software-as-a-service future. Office and other software products have all
transitioned to the cloud and it’s a virtual monopoly on office software so customer adoption
is all but guaranteed. That’s going to mean a steady stream of
revenue but at higher margins over the next few years. I’m forecasting a $1.87 dividend this year
and that’s estimating an increase to $0.49 a share in the November payment. That would mean this year’s dividend increase
is around 8.7% which is higher than the last couple of years but smaller than what we saw
in 2015 and 2016. Overall the company has done a great job at
increasing its cash payout. It returned $7.7 billion to shareholders last
quarter alone with $4.2 billion in share repurchases and $3.5 billion in dividends. With $134 billion in cash on the balance sheet
and generating $30 billion a year in cash flow, that dividend is about as safe as it
gets. What’s a little harder to explain is the
company’s increase in debt over the last five years. Ultra-low interest rates have allowed Microsoft
to tack on $60 billion in long-term debt which isn’t necessarily a problem. Interest expense is manageable and the company
has increased its balance sheet cash by almost exactly the same amount. Microsoft has always been an acquisitive company,
making some big purchases, but I’m a little worried it’s about to use a chunk of that
cash for a big expensive acquisition and I’m not sure it really needs it right now. The company’s strength is that it already
has so much of that traditional hardware on-site at companies so it’s got a foot in the door
and can convince customers to transition to its new cloud services seamlessly. You really get the sense that cloud is a two-horse
race between Microsoft and Amazon. AWS bolted out of the gate and really surprised
everyone but Microsoft has used its legacy on-premise strength to catch up and come out
a length ahead. In fact, gaming is really the only soft point
for the business, last quarter and into the foreseeable future. Fading interest in Fortnite and weak console
sales contributed to disappointing revenue last quarter and the this is one segment where
Microsoft really hasn’t proven its long-term dominance. Gaming is about 9% of total revenue and still
growing double-digits year-over-year so not bad but trailing the strength in other segments. Taking all this together, we can get a sense
for a Microsoft stock price target and where shares go from here. First though, if you’re liking the video,
do me a favor and tap that thumbs up button below. Microsoft is heavily covered with 27 analysts
providing estimates. Michael Turits at Raymond James has the high
target of $163 a share for about an 18% upside. John Difucci at Jefferies has the low target
at $93 a share and 33% downside. Most of the analysts are expecting right around
that $150 to $160 price range. That would put the shares at 27-times my $5.70
earnings estimate. It’s a little lower than the current PE
but still really high on a historical basis. There’s a lot of positivity around continued
growth in Azure and stronger profitability. Investors are no longer really worried about
that sales cliff for legacy products like Office or some of the hardware. I get the sense that things are almost too
good at Microsoft and the market knows it. The last few quarters have been really good
and it feels like this best-case scenario is priced into the shares. Cloud and Azure will surely continue to grow
but at a slower rate and any headline risk outside that perfect scenario is going to
test investor sentiment. I think the $150 to $160 price target among
analysts is probably on the high side but still represents a solid 11% gain on the shares. I’m doubtful the PE ratio can go beyond
that 30-times level so shares hit a ceiling at $170 and could potentially be stuck around
$142 on any kind of bad news and maybe a 25-times PE multiple. I don’t see the shares as hugely overvalued
which is actually saying something considering most of the market is pretty expensive. Microsoft really does have something with
its cloud growth and that’s going to propel sales for a while. I definitely don’t think you should expect
27% annual returns over the next five years but I’d feel comfortable buying shares now
for a good long-term investment. Don’t miss my analysis in shares of Apple
and Ford by clicking on the videos to the right, one of which could produce a 25% upside. Join the Let’s Talk Money community by tapping
that subscribe button and the bell notification.

7 Comments

  • Let's Talk Money! with Joseph Hogue, CFA

    Don't miss my complete analysis of Ford and it's massive 6.7% dividend! 😲 https://youtu.be/pZYR5fDAVNM

  • Raging Sweater

    Hi Joseph, thank you for the great analysis! I see you mentioned CSCO a few times, I would be interested in your analysis on this stock 🙂 By the way, as end of year coming, what's your opinion on selling some of the "lost battle" stocks to even out the profit gain and avoid capital gain tax?

  • xZeekez

    Thank you for this analysis. Would appreciate it if you could do one for either of these companies: Solaredge Technologies Inc (SEDG), Mastercard Inc (MA.NB) and Medtronic PLC (MDT.NB). Thank you for the great content!

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