Microsoft (NASDAQ:MSFT) has a strong track record of generating top-line growth, and despite the challenging economic climate, the company has managed to post reasonably constant profit margins. Additionally, Microsoft stock has a long growth runway given its capacity to take advantage of business prospects in the AI sector. With this latest article, I give a Buy recommendation for Microsoft stock.
What Investors Need to Know About Microsoft Stock
Microsoft is the top software firm in the world and is known for its operating systems and office productivity tools. The Azure and Xbox divisions of Microsoft are also among the market leaders in the global markets for console games and cloud computing, respectively. These are Microsoft’s fundamentals.
When evaluating any stock as a potential investment, the 80/20 rule or Pareto Principle is taken into consideration. Investors should actually concentrate on a few elements that have a disproportionate impact on a company’s business prospects.
Profit margins, predictability of revenue, and artificial intelligence are the three main aspects of Microsoft stock that, in my opinion, investors should be aware of.
In the next paragraphs of the post, I will go into more detail about the aforementioned points.
Profits & Margins
Despite a modest -0.8% sales miss in the most recent quarter, Microsoft managed to post a slight +0.3% earnings beat for the Q2 FY 2023 (YE June) financial period. Microsoft’s Q2 FY 2023 bottom line exceeded expectations in large part due to higher profit margins than anticipated.
According to S&P Capital IQ data, Microsoft’s Q2 FY 2023 non-GAAP adjusted operating profit margin was 40.9%, which was +120 basis points better than the consensus operating margin expectation of Wall Street analysts, which was 39.7%.
Microsoft stated that its actual non-GAAP adjusted operating costs for the most recent quarter came in about $0.5 billion lower than the firm had previously projected at its Q2 FY 2023 results briefing on January 24, 2023.
Microsoft anticipates that for the entire fiscal year FY 2023, the company’s adjusted operating profit margin will decrease by roughly 200 basis points, excluding the impact of accounting estimate changes and restructuring charges. In other words, according to MSFT’s management guidance, its headline operating income margin (accounting estimate modifications and restructuring charges included) is only anticipated to decline by about 1% in fiscal 2023, which is quite a feat.
Microsoft notably addressed “aligning our own cost structure with our revenue growth” during the most recent quarterly investor call. The company is able to maintain good profit margins even when its revenue is under pressure from macroeconomic challenges, as evidenced by Microsoft’s reasonably encouraging FY 2023 operating profit margin estimate.
According to data from S&P Capital IQ, Microsoft has had a growth in sales in 18 of the last 20 years. In the coming ten years, according to sell-side analysts, Microsoft will keep growing its top line annually.
The idea that Microsoft’s future revenue growth is observable and predictable is supported by a crucial statistic known as commercial RPO, or remaining performance obligation.
Commercial RPO, which consists of “unearned revenue and sums” that will be “recognized as revenue in future quarters,” is what Microsoft refers to as the “commercial component of revenue assigned to remaining performance obligations” in its 10-K filing.
As of December 31, 2022, Microsoft’s commercial RPO increased by +29% to $189 billion, or about one year’s worth of the company’s total revenues. Microsoft aims to have nearly half, or 45%, of its commercial RPO, accounted for as revenue in the next year, as stated on the company’s Q3 FY 2023 earnings call. More significantly, the portion of Microsoft’s commercial RPO that is anticipated to increase in value after a year increased by a significant +32% YoY.
Investors can now have faith that Microsoft is set up to continue generating solid top-line growth over the next few years.
In a recent call to discuss its Q3 financial results, Microsoft emphasized that it has “the most powerful AI supercomputing infrastructure in the cloud” and that it works with “partners like OpenAI,” which is best known for its AI chatbot ChatGPT. Microsoft has strategies in place to take advantage of connections between ChatGPT and its current products, like Azure and Bing.
In a recent research paper named “A Guide To The New Age Of AI” released by Barclays (BCS) on February 3, 2023, it was predicted that by 2026, the global “AI-based application software sales” will quadruple from $400 billion to $800 billion.
Microsoft is well-positioned to take advantage of growth prospects in AI because of its portfolio mix. The company has the luxury of investing a sizable amount of extra cash flow into emerging growth industries like AI because it is the undisputed market leader in the productivity software and computer operating system markets with its Office and Windows product lines.
What Is The Outlook Going Forward?
Long-term financial prospects for Microsoft are very favorable.
According to S&P Capital IQ’s consensus financial estimates, Microsoft’s top line is expected to increase at a +13.0% CAGR from $209.0 billion in FY 2023 to $301.7 billion in FY 2026. Additionally, analysts predict that Microsoft’s normalized EPS will go from $9.32 in FY 2023 to $15.87 in FY 2026, representing a +19.4% CAGR in the bottom line.
The company’s predictable revenue, solid profit margins, and the growth potential related to AI as described in the earlier portions of this article all contribute to Microsoft’s positive long-term prognosis.
I rate Microsoft stock as a Buy. Microsoft is a compelling investment opportunity for a number of reasons, including its top-line stability, strong expenditure management, and growth prospects relating to artificial intelligence.
Featured Image: Pexels @ Salvatore De Lellis