Investment Outlook: Microsoft (NASDAQ:MSFT) is Undervalued and Poised for Long-Term Growth
Since the release of Microsoft’s FY23 Q4 earnings, the stock has experienced a sell-off. However, we believe that this reaction is shortsighted and fails to recognize the long-term investments that Microsoft is making in computing and AI. In our opinion, Microsoft is currently trading below its intrinsic value and offers investors approximately 19% upside potential.
What You Need to Know
Following our previous article on Microsoft’s benefits from AI adoption, new evidence from their Q4 earnings strengthens our thesis. The key takeaway from the earnings report is Microsoft’s increased expenditure on computing, AI, and venture investments. This significant allocation of resources demonstrates management’s sense of urgency and commitment to securing the future of the company. We are upgrading our rating to a strong buy, making it the first time we have assigned such a rating to a stock.
Microsoft’s Post-Earnings Decline
Despite Microsoft’s impressive earnings results, with revenue increase of 8% YoY and net income increase of 20% YoY, the stock has experienced a decline since the earnings report. Some investors may have been concerned about the rise in capital expenditure (capex) and the perceived slowdown in Azure growth rates.
Regarding capex, Microsoft’s net capex for the three months ended June 30 has seen a significant increase compared to the previous year. While this increase may have surprised some investors, it indicates that Microsoft is prioritizing the necessary investments to remain competitive in the future.
The perceived slowdown in Azure growth is a natural outcome as the segment expands. However, as the economy recovers and Microsoft incorporates more AI services into their cloud offerings, there is a possibility of re-accelerated growth in Azure and other cloud services.
Investments in Computing and AI
Microsoft is making substantial investments in hardware, software, and private companies to ensure that they remain at the forefront of the evolving technological landscape. Their efforts include expanding data centers, utilizing cutting-edge hardware, and providing AI-based software to enhance business efficiency.
Microsoft has a competitive advantage over Amazon and Google due to their extensive software offerings that many businesses already use. Even if Microsoft’s cloud offering is slightly inferior, they can still compete on price and convenience. Moreover, Microsoft has made strategic investments in private companies, recognizing the potential for innovation to come from smaller players in the market.
While Microsoft has made both successful and unsuccessful investments in the past, their commitment to spending and innovation has enabled them to reinvent themselves and continue growing. The company’s investments in computing and AI align with their long-term vision and management’s confidence in their strategic direction.
Regarding the recent acquisition of Activision, we remain cautious and believe that Microsoft could have pursued better targets at a similar price point. However, with Microsoft’s track record, management is likely to find a way to make the acquisition value accretive.
Price Action and Valuation
This year, Microsoft has relatively mirrored the performance of the Nasdaq 100 and outperformed the S&P 500. While it has lagged behind other MAG7 members in 2023, Microsoft offers relatively lower volatility compared to its big tech peers. Although all stocks carry risk, Microsoft’s stability and potential for continued market-beating performance make it an attractive investment option.
On a forward PE basis, Microsoft appears to be moderately valued compared to its MAG7 counterparts.
Based on our proprietary models, our estimated intrinsic value for Microsoft is approximately $390.23 per share, indicating a potential upside of around 19% from its current price. We believe that a valuation of nearly $3 trillion is fair for Microsoft, considering its fundamentals, growth potential, and risk profile.
Risks to Consider
One of the main risks associated with Microsoft’s investments in computing and AI is the potential for these expenditures to not yield the desired outcomes. However, standing still and being complacent is even riskier in the fast-paced technology sector. We believe that Microsoft’s management is taking proactive steps to position the company for future success, and their commitment to investing in the future sets them apart from their competitors.
In conclusion, Microsoft’s recent decline in stock price presents a buying opportunity for long-term investors. The company’s investments in computing and AI, coupled with its undervaluation, make it an attractive investment choice. Microsoft’s management’s sense of urgency and commitment to innovation, combined with its diversified business and minimal exposure to China, positions the company favorably in the long run. While short-term gains may not be as exponential as some of its peers, the potential for steady growth and lower volatility make Microsoft an appealing investment option for patient investors.
Analyst comment
Positive
As an analyst, I expect the market for Microsoft to rebound and show long-term growth. The company’s investments in computing and AI, coupled with its undervaluation, make it an attractive investment choice. Microsoft’s commitment to innovation and its diversified business position it favorably in the long run, offering steady growth and lower volatility. The potential upside is estimated to be around 19% from its current price.