Following the buzz surrounding ChatGPT’s debut and the integration of new Artificial Intelligence technologies into its 365 platform, Microsoft’s (NASDAQ:MSFT) stock enjoyed an impressive rally for nearly six months. However, this robust performance was followed by about four months of sideways movement in the stock, despite the continuous AI hype. This period of price consolidation may have positioned Microsoft for another bullish trend, which could potentially kick off with the upcoming earnings announcement scheduled for Tuesday, October 24 after the market closes.

Several factors indicate that this consolidation period has set the stage for Microsoft’s potential growth. It has lowered the stock’s earnings multiple, bringing it in line with its five-year median, moderated investors’ expectations, and formed a compelling technical chart pattern. Additionally, signs of a resurgence in the Intelligent Cloud segment and PC sales, which had been lackluster over the past year, could counter any bearish sentiment in the stock.

Earnings Estimates

Despite the explosion in generative AI, Microsoft’s earnings estimates have remained relatively stable throughout 2024, resulting in a Zacks Rank #3 (Hold) rating. Analysts anticipate sales to grow by 8.6% YoY to $54.4 billion and earnings to increase by 12.8% to $2.65 per share. It’s worth noting that Microsoft has only missed earnings estimates once in the last five years.

Several growth drivers are worth noting for Microsoft. The Intelligent Cloud segment, responsible for 42% of its overall revenue, is expected to rebound with an estimated growth of 15.5%, indicating strong demand for digital transformation solutions even in uncertain economic conditions. While the softness in the PC market could impact its personal computing business, projections from the International Data Corporation suggest a potential recovery in 2024.

Competition

Microsoft faces fierce competition in the cloud services market, particularly from Amazon (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOG). Amazon leads the market, with Alphabet showing the fastest growth. However, Microsoft has been growing faster than Amazon, allowing it and Alphabet to gain a few basis points of market share over the past year.

With Microsoft’s leadership in AI, there’s curiosity about whether businesses might increasingly prefer its platform, given the ongoing enhancements in system efficiency through AI integration. Alphabet and Amazon have also ventured into AI development, creating a race to determine who can produce the best AI products and integrate them most effectively into their platforms.

Notably, Microsoft and Amazon recently announced a significant partnership, with Amazon considering becoming a customer of Microsoft. This deal, potentially valued at up to $1 billion, includes a five-year agreement and a million licenses to use Microsoft’s 365 tools, with plans to finalize it in the near future.

Valuation

After a multi-month consolidation period, Microsoft’s earnings multiple has eased off its peak. It has dropped from trading at 37x forward earnings to 30.3x, aligning with the industry average and its five-year median. Microsoft also offers a dividend yield of 0.8% and has consistently increased its dividend payment by an average of 10% annually over the last five years.

Bottom Line

Microsoft, undoubtedly one of the strongest companies in the market, now presents an attractive opportunity for investors after the period of consolidation following earlier-year gains. The upcoming earnings report from Microsoft could be a crucial event to watch, potentially setting the stage for a year-end rally not only for the stock but also for the broader market.

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