Thematic evaluation
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Microsoft Corp. (MSFT)

October 17, 2024

Compared to: Apple, Inc. (AAPL) | Alphabet, Inc. (GOOGL) | Technology Select Sector SPDR Fund (XLK)

Our reasoning

Microsoft's current valuation appears fair, considering its strong financial performance, market leadership in cloud and AI, and robust growth prospects. While the P/E ratio is slightly above historical averages, it is justified by the company's consistent revenue growth, high profitability margins, and strong cash flow generation. The potential for continued expansion in cloud services and AI integration across its product portfolio supports the current valuation.

Key takeaways
  • Microsoft's cloud computing business, particularly Azure and Office 365, is a major driver of revenue growth and profitability.
  • The company's profitability margins are decreasing, which could be a concern for investors.
  • Microsoft has a strong liquidity position, but its cash and short-term investments are decreasing, potentially due to increased investments in growth initiatives.
  • The company's solvency is healthy, but its debt levels are increasing, reflecting its financing strategy for growth.
  • Microsoft is effectively utilizing its assets and managing its operating expenses, but it faces a number of risks, including intense competition, execution risks around its cloud and AI initiatives, and increasing regulatory scrutiny.
  • The company's valuation metrics are generally in line with its peers, suggesting a fair valuation.
  • Microsoft's stock price has generally underperformed the Technology Select Sector SPDR Fund (XLK) over the past 60 days, suggesting that it has been less successful in capturing the overall growth of the technology sector.
  • Management's guidance suggests continued double-digit revenue and operating income growth in fiscal year 2025.
  • Overall, Microsoft is well-positioned for continued growth, but it is important to monitor its financial performance and its ability to navigate these risks.
Fairly valued
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Evaluation summary

  1. Company Overview:

    • Microsoft is a technology giant with a diversified business model spanning productivity and business processes, intelligent cloud, and more personal computing.
    • Its core products and services include Office, Dynamics, LinkedIn, Azure, Windows, Surface, Xbox, and Bing.
    • Microsoft targets a wide range of customers, including individual consumers, small and medium businesses, large enterprises, and public sector organizations.
    • We will be using the Technology Select Sector SPDR Fund (XLK) as a benchmark for comparison and Apple (AAPL) and Alphabet (GOOGL) as industry peers.

  2. Financial Performance:

    • Microsoft has consistently demonstrated strong revenue growth, driven by its cloud computing business, particularly Azure and Office 365.
    • The company's profitability is high, with strong margins and a high return on assets, equity, and invested capital.
    • However, profitability margins have been declining in recent quarters, potentially due to increased competition, rising costs, or investments in new initiatives.
    • Compared to its peers, Microsoft's revenue growth has been slower than Apple's but faster than Alphabet's.
    • Its profitability metrics are generally in line with its peers, with a slightly higher return on equity than Apple and a slightly lower return on assets than Alphabet.

  3. Operational Efficiency:

    • Microsoft's balance sheet reflects a strong liquidity position, with ample cash flow from operations to cover short-term obligations.
    • However, the company's cash and short-term investments have been decreasing, potentially due to increased investments in cloud infrastructure, acquisitions, or share buybacks.
    • Microsoft generates strong cash flow from operations, which is a key driver of its financial strength.
    • The company is investing heavily in cloud infrastructure and AI, reflected in increasing capital expenditures.
    • Microsoft's free cash flow has been consistently strong, with a high free cash flow margin, indicating its ability to generate cash flow beyond its operating needs.
    • The company's dividend and share repurchase program is sustainable, supported by its robust cash flow generation.
    • Compared to its peers, Microsoft has a lower current ratio and quick ratio than Apple, indicating a slightly lower short-term liquidity position.
    • Its debt-to-equity ratio is higher than Apple's but lower than Alphabet's, suggesting a moderate level of leverage.

  4. Growth Opportunities:

    • Microsoft is well-positioned for continued growth in the cloud computing and AI markets.
    • The company's acquisition of Activision Blizzard is expected to contribute significantly to revenue growth in the gaming segment.
    • Microsoft is expanding its strategic partnership with OpenAI to deploy their models across its consumer and enterprise products.
    • The company is investing heavily in R&D to develop new AI-powered features and services, such as Copilot for Microsoft 365 and Azure Maia AI accelerator.
    • Microsoft's capital allocation strategy is focused on investing in growth initiatives, including cloud infrastructure, AI, and gaming.
    • The company has a history of successfully executing strategic plans, as evidenced by its transformation into a cloud and AI-powered technology leader.

  5. Risks and Threats:

    • Microsoft faces intense competition across all markets, including from vertically-integrated platforms and cloud-based services.
    • Execution risks around cloud and AI services, including the ability to attract users and generate sufficient revenue, are significant.
    • Cybersecurity threats and vulnerabilities in products/services could lead to reduced revenue, increased costs, and reputational damage.
    • Regulatory and legal risks related to antitrust, data privacy, trade restrictions, and tax matters are increasing.
    • Reliance on attracting and retaining qualified employees in a highly competitive talent market is a key risk.

  6. Valuation Analysis:

    • Microsoft's valuation metrics, such as P/E and EV/EBITDA, are generally in line with its peers, suggesting a fair valuation.
    • The company's strong financial performance, robust cash flow generation, and strategic investments in growth initiatives suggest a positive future outlook.
    • Potential catalysts for future growth include the continued adoption of cloud and AI services, the success of the Activision Blizzard acquisition, and the expansion of Copilot across its product portfolio.

  7. Price Performance:

    • Microsoft's stock price has generally underperformed the Technology Select Sector SPDR Fund (XLK) over the past 60 days, suggesting that it has been less successful in capturing the overall growth of the technology sector.
    • However, Microsoft's stock price has been more volatile than XLK, indicating a higher risk profile.
    • Compared to its peers, Microsoft's stock price has underperformed Apple but outperformed Alphabet over the past 60 days.
    • Its volatility has been lower than Alphabet's but higher than Apple's.

  8. Future Outlook:

    • Management's guidance suggests continued double-digit revenue and operating income growth in fiscal year 2025.
    • The company expects higher capital expenditures to meet growing demand for AI and cloud products.
    • Analyst estimates are generally positive, with a consensus expectation for continued growth in revenue and earnings.
    • However, the company faces a number of risks, including intense competition, execution risks around its cloud and AI initiatives, and increasing regulatory scrutiny.

  9. Summary:

    • Microsoft is a technology leader with a strong financial position, driven by its dominant cloud computing business and strategic investments in AI and gaming.
    • The company's revenue and profitability are consistently increasing, but profitability margins are decreasing, which could be a concern for investors.
    • Microsoft has a strong liquidity position, but its cash and short-term investments are decreasing, potentially due to increased investments in growth initiatives.
    • The company's solvency is healthy, but its debt levels are increasing, reflecting its financing strategy for growth.
    • Microsoft is effectively utilizing its assets and managing its operating expenses, but it faces a number of risks, including intense competition, execution risks around its cloud and AI initiatives, and increasing regulatory scrutiny.
    • Overall, Microsoft is well-positioned for continued growth, but it is important to monitor its financial performance and its ability to navigate these risks.
Peer fundamentals 
Fundamentals
Insights
  • Microsoft is a technology leader with a strong financial position, driven by its dominant cloud computing business and strategic investments in AI and gaming.
  • The company's revenue and profitability are consistently increasing, but profitability margins are decreasing, which could be a concern for investors.
  • Microsoft has a strong liquidity position, but its cash and short-term investments are decreasing, potentially due to increased investments in growth initiatives.
  • The company's solvency is healthy, but its debt levels are increasing, reflecting its financing strategy for growth.
  • Microsoft is effectively utilizing its assets and managing its operating expenses, but it faces a number of risks, including intense competition, execution risks around its cloud and AI initiatives, and increasing regulatory scrutiny.
  • Overall, Microsoft is well-positioned for continued growth, but it is important to monitor its financial performance and its ability to navigate these risks.
Analysis
  • Revenue - Microsoft's revenue is consistently increasing, driven by strong growth in its cloud computing, gaming, and other segments. - The company's cloud computing business, led by Azure and Office 365, is a major driver of revenue growth. - The acquisition of Activision Blizzard is expected to contribute significantly to revenue growth in the gaming segment. - The company's revenue growth is sustainable, driven by its strong position in key markets and its strategic focus on cloud computing and AI.
    • Profitability
      • Microsoft is highly profitable, with strong margins and a high return on assets, equity, and invested capital.
      • The company's profitability is driven by its strong pricing power, efficient cost management, and strategic focus on high-growth areas like cloud computing and AI.
      • However, profitability margins are decreasing, which could be a concern for investors. This could be due to increased competition, rising costs, or investments in new initiatives.
    • Liquidity
      • Microsoft has a strong liquidity position, with ample cash flow from operations to cover short-term obligations.
      • However, the company's cash and short-term investments are decreasing, which could be a concern for investors. This could be due to increased investments in cloud infrastructure, acquisitions, or share buybacks.
    • Solvency
      • Microsoft has a healthy solvency position, with a low debt-to-equity ratio and a strong ability to cover its debt obligations.
      • However, the company's debt levels are increasing, which could be a concern for investors. This could be due to increased borrowing to fund operations or acquisitions.
    • Operational Efficiency
      • Microsoft is effectively utilizing its assets to generate revenue, as evidenced by the increasing fixed assets and strong return on assets.
      • The company is also effectively managing its operating expenses, with growth in expenses outpaced by revenue growth.
    • Cash Flow Analysis
      • Microsoft generates strong cash flow from operations, which is a key driver of its financial strength.
      • The company is investing heavily in cloud infrastructure and AI, which is reflected in the increasing capital expenditures.
      • The Activision Blizzard acquisition has significantly impacted investing activities, resulting in a large cash outflow.
      • The company is effectively managing its working capital, as evidenced by the increasing cash flow from operations.
    • Risk Factors
      • Intense competition across all markets, including from vertically-integrated platforms and cloud-based services.
      • Execution risks around cloud and AI services, including ability to attract users and generate sufficient revenue.
      • Cybersecurity threats and vulnerabilities in products/services that could lead to reduced revenue, increased costs, and reputational damage.
      • Regulatory and legal risks related to antitrust, data privacy, trade restrictions, and tax matters.
      • Reliance on attracting and retaining qualified employees in a highly competitive talent market.
    • Future Outlook
      • Microsoft is well-positioned for continued growth in the cloud computing and AI markets.
      • The company's strong financial performance, robust cash flow generation, and strategic investments in growth initiatives suggest a positive future outlook.
      • However, the company faces a number of risks, including intense competition, execution risks around its cloud and AI initiatives, and increasing regulatory scrutiny.
      • It is important to monitor the company's financial performance, particularly its cash flow generation, debt levels, and profitability margins, to assess its ability to navigate these challenges and sustain its growth trajectory.
Most recent earnings report
Financial statements 
All public filings
Comparative Analysis
Benchmarks (as of 2024-10-16)
Technology Select Sector SPDR Fund (XLK)
  • Performance Comparison:
    • MSFT has generally underperformed XLK over the period, with the exception of the 1-week period. This suggests that MSFT has been less successful in capturing the overall growth of the technology sector.
    • The underperformance is particularly pronounced over longer periods, such as the 2-year and 3-year periods. This suggests that MSFT's growth has been slower than the broader technology sector.
  • Risk and Return Analysis:
    • MSFT has provided lower annualized returns than XLK over the period. This is consistent with the underperformance observed in the historical performance analysis.
    • MSFT has generally been more volatile than XLK, as indicated by its higher annualized volatility. This suggests that MSFT's stock price has been more sensitive to market fluctuations.
    • MSFT experienced a larger maximum drawdown than XLK during the period. This indicates that MSFT's risk profile is higher than XLK's, as it has the potential to experience larger losses during market downturns.
  • Risk-Adjusted Performance:
    • MSFT has offered a better risk-adjusted return than XLK, as indicated by its higher Sharpe Ratio. This suggests that MSFT has been able to generate higher returns for the level of risk taken.
    • MSFT's beta suggests that it is slightly less sensitive to market movements than XLK, indicating a slightly lower risk profile. This is consistent with the higher Sharpe Ratio observed for MSFT.
  • Overall Assessment:
    • MSFT has underperformed XLK over the period, but it has offered a better risk-adjusted return. This suggests that MSFT's growth has been slower than the broader technology sector, but it has been able to generate higher returns for the level of risk taken.
    • MSFT's higher volatility and larger maximum drawdown indicate a higher risk profile than XLK. However, its higher Sharpe Ratio suggests that it has been able to manage this risk effectively.
    • Investors looking for a technology stock with a lower risk profile and a better risk-adjusted return may consider MSFT. However, investors seeking higher growth potential may prefer XLK.
Peers Price History(as of 2024-10-16)
Apple, Inc. (AAPL)Alphabet, Inc. (GOOGL)
  • Performance Comparison:
    • MSFT has exhibited a mixed performance history compared to its peers, AAPL and GOOGL. While it has outperformed GOOGL over longer periods like 2 years and 3 years, it has consistently underperformed AAPL in most timeframes, particularly in the shorter term. This suggests that MSFT's growth trajectory might be slower than AAPL's, but it still holds a competitive edge over GOOGL.
  • Risk and Return Analysis:
    • MSFT's annualized returns have been generally lower than AAPL's but higher than GOOGL's. This indicates that while MSFT might not be as aggressive in growth as AAPL, it still offers a more stable and consistent return compared to GOOGL.
    • MSFT's annualized volatility has been generally lower than GOOGL's but higher than AAPL's. This suggests that MSFT's stock price is less susceptible to extreme fluctuations than GOOGL, but it is more volatile than AAPL.
    • MSFT's maximum drawdown of 37.15% is higher than AAPL's 30.91% and GOOGL's 44.32%. This indicates that MSFT's risk profile is higher than AAPL's but lower than GOOGL's.
  • Risk-Adjusted Performance:
    • MSFT's Sharpe Ratio has generally been lower than GOOGL's but higher than AAPL's. This suggests that GOOGL has provided better risk-adjusted returns than MSFT, while MSFT has provided better risk-adjusted returns than AAPL.
    • MSFT's beta values suggest that it is more volatile than the overall market. However, its beta values have been generally lower than those of AAPL and GOOGL, suggesting that it is less sensitive to market movements than its peers.
  • Overall Assessment:
    • MSFT presents a balanced investment proposition. While it might not offer the same aggressive growth potential as AAPL, it provides a more stable and consistent return with lower volatility compared to GOOGL. Its risk profile is higher than AAPL's but lower than GOOGL's, making it a potentially attractive option for investors seeking a moderate risk-reward balance.
    • The recent trends in volatility and drawdowns suggest that MSFT might be becoming more sensitive to market fluctuations. This could be a cause for concern for investors seeking a more stable investment. However, MSFT's strong fundamentals and diversified business model provide a degree of resilience.
Peers Fundamentals(as of 2024-06-30)
Apple, Inc. (AAPL)Alphabet, Inc. (GOOGL)

  1. Market Position and Size:

    • MSFT is the second largest company in the peer group with a market cap of 3070740.0, significantly smaller than AAPL's 3493750.0 but larger than GOOGL's 1991510.0.
    • MSFT's market cap is generally in line with its revenue, EBITDA, and net income compared to its peers, suggesting that the market values its financial performance consistently with its peers.

  2. Profitability and Efficiency:

    • MSFT significantly outperforms its peers and industry averages in profitability metrics, demonstrating its strong operating efficiency, cost control, and ability to generate substantial profits.
    • MSFT's return on average assets, return on average total equity, return on average total capital, and return on average invested capital are generally strong, although it lags behind AAPL in some key metrics.

  3. Financial Health and Stability:

    • MSFT demonstrates a moderate level of liquidity and a conservative debt position, indicating a strong financial health and stability relative to its peers and industry norms.
    • Its balance sheet structure is generally similar to its peers, with a higher proportion of total assets and a lower level of long-term debt, suggesting a more conservative financial approach.

  4. Valuation and Market Perception:

    • MSFT's valuation metrics indicate that the market perceives it as a high-growth, profitable company with strong future prospects, although its valuation is generally lower than AAPL's.
    • The market values MSFT's sales, EBITDA, and earnings at a premium compared to its peers, reflecting its strong growth prospects and market dominance.

  5. Cash Flow and Capital Management:

    • MSFT demonstrates strong cash flow generation capabilities, reflecting its efficient business model and strong customer base, although its free cash flow is lower than AAPL's.
    • MSFT is investing in its growth, but at a more moderate pace compared to GOOGL, suggesting a balanced approach to capital allocation.

  6. Growth and Future Prospect:

    • MSFT consistently shows higher growth in sales/revenue, EBITDA, net income, basic earnings per share, and free cash flow compared to the peer group average, suggesting that it is effectively capitalizing on market opportunities and expanding its market share.
    • The acceleration in growth rates over the past five years further reinforces this positive outlook, indicating a promising future for MSFT.

  7. Potential for Investment:

    • MSFT presents an attractive investment opportunity, considering its size, growth potential, profitability, efficiency, financial stability, and valuation compared to both peers and industry benchmarks.
    • Its strong financial performance, sustainable growth, and efficient cash flow generation suggest a promising future.
    • However, investors should consider the risks associated with its lower return on equity and liquidity compared to its peers.

  8. Key Risks and Considerations:

    • MSFT's lower return on equity compared to AAPL suggests that AAPL may be more efficient in generating returns for its shareholders.
    • MSFT's lower liquidity compared to GOOGL suggests that GOOGL may have a more flexible financial position.
    • The market's perception of MSFT's growth prospects and business model may change, leading to a decline in its valuation.

  9. Overall Assessment:

    • MSFT exhibits strong financial health and performance relative to its peer group and industry averages. Its strong profitability, efficient cash flow generation, and sustainable growth demonstrate its ability to generate substantial profits and expand its business.
    • While MSFT's return on equity is lower than AAPL's and its liquidity is lower than GOOGL's, its overall financial health is still strong, reflecting its conservative financial approach and efficient operations.
    • MSFT holds a strong competitive position within its peer group and the broader industry, with a promising future driven by its strong financial performance and growth trajectory.