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Where will Microsoft Stock be in 5 years? (NASDAQ: MSFT)

Sean Gallup

Summary in seconds

I rate Microsoft Corporation (NASDAQ: MSFT) stock as a purchase.

In my previous update for Microsoft written on April 8, 2022, I assessed MSFT as a potential metaverse game. This current article discusses Microsoft’s mid-term outlook and whether it has fully factored into MSFT’s share price and valuations.

Based on my analysis, Microsoft should be able to maintain a reasonably rapid pace of revenue expansion and increase operating profit margins over the next five years. But MSFT’s current PEG (Price/Earnings-to-Growth) ratio is below the historical average, indicating a mismatch between the stock’s current valuations and the company’s future growth prospects. As such, I improve my rating for MSFT from a Hold to a Buy.

Key Microsoft Stock Indicators

MSFT announced the company’s financial results for the fourth quarter of fiscal 2022 (YE June 30) with an earnings press release issued July 26, 2022. Although the most recent quarterly earnings per share or EPS of $2.23 to be below the Wall Street consensus estimate of $2.29 by -3%, mainly driven by some one-time items. MSFT noted during its fourth quarter fiscal 2022 earnings briefing on July 26, 2022 that the increase in operating costs in the last quarter “included approximately 2 points from the decision to reduce operations in Russia , employee severance benefits and the impact of the acquisition of Xandr (completion June 2022).”

Beyond the lack of EPS, Microsoft’s performance over the past quarter has been reasonably good judging by some key metrics.

First, MSFT reported +46% YoY revenue growth for Azure and other cloud services in the fourth quarter of FY2022, at constant currency. That’s faster than the currency-adjusted +45% year-over-year revenue increase that Microsoft provided for the fourth quarter of fiscal 2021. More importantly, Microsoft mentioned during its recent quarterly call to investors that it had observed “larger and longer-term commitments” for Azure, which bodes well for the long-term growth prospects of this business.

Second, the company’s Office 365 Commercial product line saw strong currency-adjusted revenue growth of +19% YoY in the last quarter of fiscal 2022. The main driver was Office 365 E5 , which MSFT describes as “a cloud-based suite of productivity apps combined with advanced voice, analytics, security and compliance services.” During the company’s fourth quarter investor briefing, Microsoft mentioned that “demand for security, compliance, and voice value in Microsoft 365 drove strong momentum at E5.” Specifically, the number of Office 365 E5 seats grew by more than +60% YoY in the last quarter to represent 12% of the Office 365 installed base.

Third, Microsoft revealed during its fiscal 2022 fourth quarter earnings call that the company took market share from competitors in key areas of its business in the last quarter. The industries in which MSFT has gained market share include Teams, Windows for PC, Security, Data, and AI, among others. This is the best form of validation of MSFT’s execution capabilities and the value proposition of its products.

Should Microsoft grow?

Microsoft is expected to grow further in the near term, despite macroeconomic headwinds.

MSFT offered management advice suggesting it can deliver “double-digit revenue and operating income growth in constant currency and US dollars” for the full fiscal year 2023, according to management’s comments during the recent Q4 2022 earnings call. Microsoft also mentioned during the recent quarterly investor briefing that negative currency effects are expected to be around -400 basis points for the company’s revenue growth over the course of the year. financial year 2023.

In other words, this implies that MSFT expects the company to achieve revenue growth of at least +14% (expected double-digit revenue growth and 4% currency impact). in terms of constant exchange rates. A possible slowdown in Microsoft’s constant-currency revenue expansion from +19% in fiscal 2022 to +14% in fiscal 2023 explains why the company’s shares underperformed the broader market in this calendar year so far.

Microsoft stock has corrected -23.5% in 2022 year-to-date, while the S&P 500 has declined a relatively milder -18.2% over this period. In summary, MSFT should still post decent positive growth this year, but investors nonetheless penalized the stock due to slower near-term growth expectations.

What are the Microsoft enablers to watch out for?

As noted in the previous section, shares of MSFT have underperformed the S&P 500 year-to-date. Microsoft’s current consensus calls for a normalized P/E multiple for the next twelve months of 25.1 times according to S&P Capital IQ is below its three- and five-year average PER ratios of 30.8 times and 28.5 times, respectively. This raises the question of whether there are any revaluation catalysts to watch.

In my opinion, there are three catalysts for Microsoft that investors should pay attention to.

The first catalyst is Azure’s sustained growth momentum.

Azure is by far the fastest growing industry for MSFT. As previously reported, constant currency revenue growth for Azure and other cloud services was an impressive +46% year-over-year in the fourth quarter of fiscal 2022. at constant currencies over the last quarter.

Even though market conditions are challenging, Microsoft has still guided very strong constant currency revenue growth of +43% YoY against Azure and other cloud services in Q1 FY2023. given that the transition to the cloud is a key element in the growth of many companies. plan to optimize their costs, Azure’s near-term growth may prove more resilient than the market expects.

The second catalyst is better than expected profitability.

Microsoft’s management forecast for fiscal year 2023 indicates that the company’s operating profit margin is maintained at the same level as fiscal year 2022 when taking into account currency effects.

Chances are that MSFT could meet or even exceed its FY2023 operating profitability guidance by slowing its pace of hiring. A before July 20, 2022 Looking for new Alphas The article pointed out that MSFT was “cutting off a number of open job postings.” Separately, Microsoft noted on its recent quarterly earnings call that the rate of increase in its operating costs “will moderate significantly over the course of the year as we slow the hiring rate.”

The third catalyst is the completion of the Activision Blizzard transaction.

In my early April 2022 post, I highlighted that “MSFT’s proposed acquisition of Activision Blizzard (ATVI) is another key step in the company’s plans to capitalize on metaverse growth opportunities. of the consumer”. As such, completing this deal will boost Microsoft’s long-term growth ambitions in the Metaverse.

Notably, the CEO of Activision released a letter he wrote for his staff on September 1, 2022. In the letter, the CEO of Activision reiterated previous indications that the Microsoft-Activision transaction will be completed before the end of fiscal year 2023 on the basis that regulatory progress is in line with expectations.

In the next section, I focus on the 5-year outlook for Microsoft stock.

Where will Microsoft Stock be in 5 years?

Five years from now, I think Microsoft will become a more profitable company in terms of operating profit margins, while maintaining a reasonably fast pace of growth.

In specific quantitative terms, I expect MSFT to achieve a low to medium revenue percentage CAGR over the next 5-year period. According to my estimates, Microsoft’s EBITDA and EBIT margins should increase by at least +200 basis points (on a cumulative basis) over the next five years. This should translate to a five-year EPS CAGR of over +15% for Microsoft going forward.

Microsoft’s strong revenue growth projection in the coming years is realistic. MSFT is set to be one of the main beneficiaries of the secular trend of digital transformation, and its wide range of products and services is well positioned to win a growing share of customer spending on IT. ‘information.

In terms of improving operating profitability, Microsoft’s profit margins are expected to increase due to positive operating leverage. In particular, MSFT’s cloud/Azure business line should see much greater economies of scale over time. Microsoft’s Intelligent Cloud segment recorded $75.3 billion in revenue in fiscal year 2022, and the business segment is expected to easily cross the $100 billion mark in the next five years, which could be a inflection point for profit margins for the Intelligent Cloud segment and the enterprise as a whole. .

Is the MSFT stock a buy, sell or hold?

I rate MSFT stock as a buy. Microsoft shares are undervalued based on a historical comparison of the PEG valuation metric. MSFT is currently trading at a PEG ratio of 1.67x (P/E multiple of 25.1x and my expectation of long-term annualized EPS growth of +15%). Over the past five years, MSFT has traded at a higher average PEG multiple of approximately 1.9x according to S&P Capital IQ The data. In conclusion, I think Microsoft warrants a Buy rating, as its valuations do not reflect the company’s medium to long-term earnings growth potential, as indicated by the PEG ratio.