Microsoft fetches a steep premium to the broader market.
The second-largest company on earth, Microsoft (MSFT 1.05%), has had quite a year, as its stock has risen roughly 40% in 2023. That's an incredible performance for a company worth nearly $2.5 trillion, but it makes many investors question if there is room for more.
Questions about the economy's stability, rising interest rates, plus the market becoming expensive make many investors question if there are better stocks out there. With Microsoft making up nearly 10% of the Nasdaq-100 and just under 7% of the S&P 500, it's an excellent bellwether stock for determining how far the markets have left to run. Let's find out if Microsoft has peaked or if other drivers can push it even higher in 2023.
Microsoft's product offering is immense
Microsoft has its hands in several areas. Most people with a computer are familiar with the Microsoft Office products that come standard on nearly every device. But it also has other products like its Azure cloud computing product, Xbox, and advertising revenue from LinkedIn.
The most promising segment is Azure, the driving force behind Microsoft's impressive stock run over the past five years (Microsoft is up over 200% versus the S&P's 70% rise). Azure provides the infrastructure to run cloud workloads, including artificial intelligence (AI) ones. In the latest quarter, Azure grew by 26%, tying it with Dynamics 365 as the fastest-growing segment within Microsoft. However, this division has room for incredible upside if AI takes off.
A new part of the Microsoft investment thesis is its planned acquisition of Activision Blizzard (NASDAQ: ATVI). Although Microsoft announced this acquisition in January 2022, it has made several concessions to regulators to get them to approve the deal, although it must be completed before Oct. 18. Should Microsoft complete this deal, it will strengthen its gaming division and cement Xbox as the top gaming system to own (even though Microsoft has pledged to keep its games on rival devices for a decade).
Microsoft is a massive company, and its products span throughout the tech space. But, this wide approach can have drawbacks when some areas aren't doing well. The More Personal Computing division, which encompasses Xbox consoles, laptops, and other devices, was down 4%. Still, strength in Intelligent Cloud (up 15%) and Productivity in Business (up 10%) offset this weakness and allowed Microsoft to grow by 8% in the fourth quarter of fiscal year 2023 (ended June 30).
That's less than market-average growth, and the first quarter of 2024 looks no different. Revenue is expected to be around $54.3 billion, indicating the same 8% growth rate.
But revenue isn't the only thing investors should consider, as Microsoft is a mature company. Earnings per share (EPS) rose 21% in Q1, and Wall Street analysts project 13% growth in fiscal year 2024.
Still, that's not a ton of growth to pay for the relatively high price of Microsoft's stock.
Microsoft's stock is fairly expensive
Microsoft's stock is trading at the high end of its price-to-earnings (P/E) ratio over the past four years, and its forward P/E (which factors in projections) isn't much better.
MSFT P/E Ratio data by YCharts.
With Microsoft's stock already fetching a premium price, any future performance must come solely from the business side. With EPS expected to grow at more than 10%, it could still be a market-beating investment. However, the stock's premium (or how much an investor is willing to pay for Microsoft) may also decrease, which could offset business gains.
For a broader perspective, if you compare it to other tech giants like Alphabetand Apple, Microsoft is more expensive as each of these companies' stocks trade at 29 times earnings. It's also significantly more expensive than the S&P 500, which sports a PE ratio of about 25.
As a result, I think Microsoft isn't a buy here, but if you already own the stock, it's not a sell. Microsoft isn't in danger as an investment, but there are better opportunities out there that are growing faster and can be purchased at a lower price. Plus, with how large of a component Microsoft is in the primary indexes, it's likely that many investors already have significant Microsoft exposure, and adding more seems unnecessary, at least right now.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Keithen Drury has positions in Alphabet. The Motley Fool has positions in and recommends Activision Blizzard, Alphabet, Apple, and Microsoft. The Motley Fool has a disclosure policy.
