Is Microsoft a Buy? | The Pied Fool

Microsoft (MSFT -1.64%) he had a good last few years. Its valuation (by market capitalization) has nearly tripled in the past three years, and is now in the $3 trillion club, with Apple being the only other member at the moment.

Microsoft stock’s performance has been impressive, but it recently hit a slump. As of September 5, it has fallen more than 12% since hitting an all-time high on July 5. It is also under performing S&P 500 this year, which most people probably wouldn’t have guessed given his strong start.

It’s always best to zoom out and think about the big picture when analyzing a stock’s performance, but it’s hard to ignore Microsoft’s recent declines since July. Some may question whether Microsoft is a buy or whether it should hold off until a more “ideal” time. Let’s take a look.

Profitability continues its momentum

Microsoft consistently puts up good financial numbers, and its last quarter was no different. Revenue and operating income grew 15% year-over-year, which is impressive for a company of its size. Its earnings per share (EPS) were $2.95, beating analysts’ estimates. It’s also more than double what it was five years ago.

MSFT EPS diluted (quarterly) data by YCharts

Microsoft’s EPS growth is a testament to its ability to increase profitability while growing at the steady pace it has. Its shares outstanding have only fallen about 3% over the past five years, so much of the growth can be attributed to its earnings improvement.

You have to pay to play

The only downside to Microsoft’s latest gains came from its cloud platform, Azure. Microsoft doesn’t release revenue figures for the Azure platform alone, but “Azure and other cloud services” revenue grew 29% year over year. This is a slowdown from previous quarters, but not cause for alarm in my view.

Given how much attention artificial intelligence (AI) has received and how it should boost cloud platforms like Azure, it makes sense for investors to put a microscope on that side of Microsoft’s business. However, it is a bit early to determine the full impact of AI.

Microsoft plans to ramp up capital spending, with the overwhelming majority going to its cloud business and building out its AI infrastructure. It spent $55.7 billion in fiscal 2024, including $19 billion in the fourth quarter. Investors usually don’t like hearing that a company plans to increase spending, but it’s a means to an end, especially if Microsoft wants to continue to compete with Amazon Web Services (AWS).

MSFT data on capital expenditure (annual) by YCharts

AWS is the leading cloud platform with a 31% market share, but Azure has gained momentum. Its market share is 25%, well ahead of third place AlphabetGoogle Cloud, at 11%. AI may not have the anticipated immediate effect on Azure’s business, but it’s still well-positioned to be a high-growth area for Microsoft in the near term.

Growth with a guaranteed income side

Microsoft may not strike you as a dividend stock, but it has the highest dividend yield of the five “Magnificent Seven” companies that pay one (Amazon and adze are the two without one).

At $0.75 quarterly with a forward dividend yield of just over 0.7%, it’s not amazing. However, Microsoft has increased its dividend regularly in recent years and is almost certain to continue this streak. In September 2023, it increased its dividend by 10%, so it will be interesting to see if it increases it by the same percentage during this period.

Even Microsoft’s modest dividend helped boost its total return. Over the past decade, Microsoft’s total returns have outpaced stock price appreciation by more than 150%.

MSFT data by YCharts

Microsoft’s dividend won’t carry the stock, but it’s nice to have that extra income stream to complement its strong growth.

Premium prices for a premium company

Some stocks fly under the radar and remain undervalued. Unfortunately, for investors looking for an undervalued gem, Microsoft doesn’t fit that definition. With a forward price-to-earnings (P/E) ratio of 31, Microsoft is expensive by most standards. That’s no real surprise, though; premium companies often have premium prices.

As an investor, it is your job to determine whether the premium price is worth paying. I think it is in Microsoft’s case. Its core business is solid, and continued cloud adoption presents new growth opportunities. Long-term investors should not place too much weight on Microsoft’s current valuation.