Is MSFT Stock A Buy, Sell, or Hold?

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MSFT is one of the few tech stocks which trades close to all-time highs, seemingly oblivious to the brutal valuation reset that swept through the sector

In the most recent quarter, MSFT delivered strong results when factoring in the tough macro environment. MSFT grew revenues by 7% (10% constant currency) and earnings per share by 10% (14% constant currency) - two achievements not necessarily typically seen under difficult economic circumstances.

MSFT generated $8.64 billion of that operating income from its productivity and business processes segment, which houses its Office 365 product suite among others. As to be expected, LinkedIn revenue growth came in light at just 8%, a reflection of lower hiring demand.

MSFT generated another $9.4 billion in operating income from its intelligent cloud segment. Azure grew at a 27% clip, far surpassing the 16% growth seen at competitor Amazon Web Services

Investors have been cautious on the ever-valuable cloud business ever since the cloud titans all revealed cloud optimization efforts undertaken by its customers. On the conference call, management implied that they may see easing headwinds as they pass the anniversary of those optimization efforts, stating that “at some point, workloads just can't be optimized much further.” It is possible that MSFT’s partnership with ChatGPT’s creator OpenAI has something to do with that, as management noted that while they do not consolidate any operating losses due to them holding a minority equity interest, they do indeed recognize revenues generated from OpenAI using their cloud services. The other cloud titans did not offer the same bullish commentary surrounding the end of cloud optimization.

MSFT continued to see headwinds from its more personal computing segment, which saw revenues decline by 9% though still managed to generate $4.24 billion in operating income. At some point the comps should become easier here, but that may still be a couple of quarters away.

MSFT ended the quarter with $104.5 billion in cash versus $48.2 billion in debt. I note that the company also has another $9.4 billion in equity investments (the announced $10 billion investment in OpenAI is set to take place in parts throughout the year).

The company continues to pay a growing dividend and conducted $5.5 billion in share repurchases in the quarter. It is not too often that one can get long term innovation and have the majority of free cash flow returned to shareholders as well.

Looking ahead, management has noted that overall growth may struggle due to the prior year’s quarter being a tough comp, with that being their “largest commercial bookings quarter ever with a material volume of large multiyear commitments.” Management did, however, guide for up to 27% in Azure growth, which seems to imply that the bottom for that segment may be very near if not already passed. Investors may be worried about how ongoing tech layoffs may impact Office 365 growth, but management appeared unfazed by this risk, citing that they continue to see strong demand for their product suites.

MSFT continues to show why it is a favorite tech stock in growth allocations, as it has shown resilient growth in the face of tough macro. The strong fundamentals have helped the stock sustain a premium valuation multiple, as the stock recently traded hands at just under 35x earnings.

Valuation remains the most obvious risk with that stock trading something between 50% and 100% higher than GOOGL depending on how many adjustments applied to the latter. With the stock trading so richly on present earnings, the stock could go nowhere for 7-10 years and still be trading at around 15x earnings at that time. Unless MSFT manages to sustain double-digit earnings longer than consensus, the stock will likely need to sustain a rich multiple in order to beat the market index. I note that this risk does not appear as large at the aforementioned mega-cap peers due to not just lower valuations but also due to MSFT appearing to already be operationally efficient with operating margins in excess of 40%. Another risk is that of potential disruption to its enterprise tech business. Wall Street appears to view the stock as being the strongest operator in any of its competing markets, but I do not share such views. In particular, I view competition from the likes of CrowdStrike (CRWD),and GOOGL’s productivity suite as being underestimated risks. It is possible that MSFT is about to face long- term disruption just as its growth story is decelerating - which would have a catastrophic impact on multiples. Due to the near term upside from OpenAI, MSFT hit ATH and now its in pullback mode, I took huge profit and waiting for more confirmation

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