Microsoft Corporation Will Keep Grinding Higher, But Slower

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MSFT stock - Microsoft Corporation Will Keep Grinding Higher, But Slower

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If you’re a reader of my work, you know that I’m usually quite bullish on big tech names.

I think Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOG,NASDAQ:GOOGL) are the quintessential “big growth at a big discount” stocks. Amazon.com, Inc. (NASDAQ:AMZN) and Netflix, Inc. (NASDAQ:NFLX) are leading players in secular growth markets. Both will inevitably grow into their valuations. Meanwhile, Alibaba Group Holding Ltd (NYSE:BABA), JD.Com Inc(ADR) (NASDAQ:JD), and Baidu Inc (ADR) (NASDAQ:BIDU) are pure plays on the huge urbanization story underway in China.

But one big tech name I have had trouble getting bullish on at these levels is Microsoft Corporation (NASDAQ:MSFT). I was exceptionally bullish on the stock when it was $40 back in 2015. But ever since the stock hit $70, I went neutral due to what I perceived as a full valuation.

Admittedly, I’ve been wrong on the name. MSFT stock is up more than 20% since I went neutral. As it turns out, MSFT stock just continues to rally with the rest of big tech.

This trend will likely continue. As long as the cloud and Internet of Things (IoT) growth narratives continue to accelerate, MSFT stock will grind higher.

But because the valuation does look full, MSFT stock likely won’t be the biggest winner going forward. I think stocks like FB and GOOG will generate much more alpha.

MSFT Is Not a Hyper-Growth Company

MSFT is a stable growth company with a few hyper growth aspects. But the market is valuing MSFT stock as if the whole company had hyper-growth potential.

It doesn’t.

Yes, Azure and Office 365 are big growth drivers. Azure revenues jumped 90% year-over-year last quarter. As more and more data continues to migrate to the cloud, Azure’s revenue growth will remain big.

Meanwhile, Office 365 has been a huge success for the company. MSFT has successfully turned its old school, disks-and-download Microsoft Office model into a cloud solution. Demand has been huge. Office 365 commercial revenues jumped 42% higher last quarter.

But growth is slowing in these all-important segments. Over the past several quarters, Azure revenue growth has gone from 120% to 90%. That is a natural slowdown from such big growth rates, but it is nonetheless a slowdown that will continue as the base gets larger.

Meanwhile, Office 365 commercial revenue growth has gone from 54% to 42% over the past four quarters.

These slowdowns wouldn’t be a problem if growth was big elsewhere in the company. But it’s not. Product revenue fell 5% last quarter. That’s big, because product revenue accounted for nearly 60% of total revenue last quarter. Enterprise Services revenue growth is flat. Gaming revenue growth is flat.

Overall, total revenue growth at MSFT last quarter was just 12%, while earnings rose 17%.

Revenue growth at FB was 47% last quarter, while earnings rose 77%. At GOOG, revenues rose 23% last quarter, while earnings rose 27%. At AMZN, revenues rose 34% last quarter, while at NFLX, earnings rose nearly 150%.

Clearly, MSFT does not belong in the same hyper-growth discussion as the FANG (Facebook, Amazon, Netflix and Google) stocks.

Valuation Is a Concern for MSFT Stock

The problem with MSFT stock is that it’s being awarded a valuation similar to some of those FANG stocks.

Consulting YCharts, we can see that long-term earnings growth at MSFT is pegged at 12%, far lower than FB (28%), AMZN (42%), NFLX (51%), and GOOG (19%).

But MSFT stock’s 1-year forward earnings multiple of 23x isn’t too far off from FB (27x) or GOOG (25x). Granted, it’s much lower than NFLX (81x) and AMZN (137x), but after considering growth, MSFT’s price-to-earnings/growth ratio (PEG) is the second highest in the group.

FB has a PEG of less than 1 (27x for 28% growth), GOOG has a PEG of 1.3 (25x for 19% growth), NFLX has a PEG of 1.6 (81x for 51% growth), MSFT has a PEG of 1.9 (23x for 12% growth), and AMZN has a PEG of 3.3 (137x for 42%).

In other words, MSFT is the least attractively valued stock in the group except for AMZN. And AMZN is flirting with super-charged earnings growth potential due to grocery market share gains, a potential entrance into the pharmacy market, and digital advertising ramp.

Consequently, I think MSFT stock is the least attractively valued stock in the group.

Bottom Line on MSFT Stock

Big tech is in favor. That means all of these stocks will keep grinding higher.

But I don’t think MSFT stock will be the biggest winner. I think gains from here will be slow and gradual.

As of this writing, Luke Lango was long FB, AMZN, NFLX, GOOG, BABA, JD, and BIDU.

 


Article printed from InvestorPlace Media, https://investorplace.com/2017/12/microsoft-corporation-msft-stock-grinding-higher-slower/.

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