Microsoft Stock: Valuation Is High for This Tech Giant

Microsoft Stock

Microsoft Stock (NASDAQ:MSFT)

While I prefer Microsoft (NASDAQ:MSFT) to those of other large tech companies such as Google (NASDAQ:GOOGL) and Apple (NASDAQ:AAPL), I believe large-cap tech stocks will not outperform in the next few years as they have in the past.

Investment Thesis

Microsoft is a high-margin cash cow that, together with Azure and other important business sectors, essentially operates an online toll booth. They are still growing domestically, but they are also investing internationally, with recent examples being Open AI and Activision. At 26.7 times earnings, I think that Microsoft’s valuation is a bit high. For the time being, I believe it is a hold, but if we reach close to 20x earnings, I will reconsider. 

The Company has continued to buy back a lot of shares despite the high valuation. The dividend, which currently yields 1.1%, has been growing for several years. With a market cap close to $2 trillion, I wonder how Microsoft stock will outperform in the future simply owing to the company’s large size.

Activision & ChatGPT

I looked at the most recent 10-Q, and I haven’t found anything that would be of interest to investors who are already familiar with the company. Revenues rose marginally, while net margins fell significantly. Microsoft is still a high-margin cash cow, but the most intriguing recent Microsoft move is its investment in OpenAI. 

GPT tool follows layoffs. Microsoft plans to cut 10,000 jobs, continuing the trend of layoffs in the tech sector in recent months. They intend to incorporate the Chat GPT tool into Bing and other Office products, but I’m interested to see how things progress and whether it adds a major capability to Microsoft’s services.

Microsoft is still in the process of completing the acquisition of Activision (NASDAQ:ATVI) which was announced almost a year ago. 

I still believe the purchase will go through at $95 per share, but various regulatory organizations, including the FTC, are looking into it. I believe the transaction will go through, but we’ll have to wait and see. Many predict the transaction to finish by the middle of 2023, providing investors with excellent double-digit returns on Activision stock. But others believe Activision might face a double-digit loss if the acquisition falls through.

Microsoft Stock Valuation

Microsoft went from being a boring value stock with a single-digit P/E ratio in 2008 and 2009 to becoming the fast-growth, high-margin cash cow that the market has rewarded with a premium multiple. 

Since 2013, we have seen steady multiple increases, which peaked at a P/E of little more than 40x in the fall of 2021. Strong operating results and growth, as well as continuous inflows from passive funds, I believe, contributed to this. While shares have dropped significantly since their high (by more than 20%), they remain costly today.

Microsoft is currently trading at 26.7 times earnings. Growth is predicted to be high in 2024 and 2025, putting shares in the hold category for the time being. I wouldn’t be a buyer over a 20x multiple, which we might not see for a while. With a market capitalization of $1.85 trillion, it’s impossible to predict huge rewards for investors based solely on market capitalization.

The ongoing share repurchase program, paired with a 1.1% dividend and a long track record of consistent growth, may entice investors.

Dividends and Buybacks

At the end of the quarter, Microsoft’s existing $60 billion authorization still had $31.5 billion left. In the first half of its fiscal year 2023, Microsoft spent $9.2 billion on share repurchases. The $1.8 billion that was spent on employee compensation shares during the first half of the fiscal year is not included in these share repurchases. Despite the fact that Microsoft has long been repurchasing shares, I don’t particularly like the present repurchase program due to its value.

I would like to see more ferocious dividend increases. I made a similar suggestion in my earlier piece, although I’d prefer to see the money go toward dividends because shares currently trade at more than 26 times earnings. 

With a payout ratio of somewhat more than 30%, there is plenty of room to increase the dividend without going overboard. The yield is 1.1%, which isn’t much for investors looking for immediate income, but the dividend has been steadily increasing for years.

There is plenty of room to raise the dividend without going crazy with a payout ratio of a little over 30%. For investors looking for quick income, the yield of 1.1% isn’t much, but the dividend has been growing consistently for years.

To Sum Up

Despite the fact that Microsoft is a remarkable company with strong margins and a solid balance sheet, I don’t think the stock will rise over its current level. This is partly because the asking price is so high—26.7 times earnings.

A few additional elements could affect the result. One of these is passive fund flows, which have benefited major tech shares over the past ten years and will do so again in 2021. 

Microsoft’s shares will decline significantly if the inflows turn outflows. The cyclical performance of the market sectors should also be looked at. After the financial circus of 2008, technology ruled supreme, but I anticipate that in the next few years, energy and real assets will outperform.

Microsoft keeps making investments in both domestic and global growth. I’m interested to see how the business incorporates Chat GPT into its offerings.

Although I think AI has its uses, I’m not sure if the hefty cost is justified. If the Activision transaction is approved, I think it will be beneficial. It will add well-known brands like Call of Duty and Candy Crush to strengthen the company’s robust gaming business. The market values Microsoft as a high-caliber company.

Some investors are willing to pay a premium for Microsoft stock right now, but for me, the shares are still too expensive at 26 times earnings and $1.85 trillion in market cap.

Featured Image: Unsplash @ Clint Patterson

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About the author: Stephanie Bedard-Chateauneuf has over four years of experience writing financial content for various websites. Over the years, Stephanie has covered various industries, with a primary focus on consumer stocks, cannabis stocks, tech stocks, and personal finance. This stock lover likes to invest for the long-term. Stephanie has an MBA in finance.