Is Microsoft Stock Overvalued?

Is Microsoft Stock Overvalued? Investors, analysts, and economists agree that tech stocks saved the market when the world effectively shut down.

By some calculations, the S&P 500 would be down year-to-date if not for the five companies that are affectionately referred to as FAAMG – Facebook (FB), Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), and Google/Alphabet (GOOG).

Instead, the S&P managed a gain despite the COVID-19 crisis that shuttered non-essential businesses, put millions out of work, and completely decimated the travel and hospitality industries. 

Now that the novelty of the crisis has passed and the market has recovered from its March 2020 crash, investors are looking towards the future and attempting to predict what comes next.

Will tech stocks continue their rise or was the September drop in tech share prices a taste of trends to come? In particular, is Microsoft stock overvalued? Given its price-to-earnings ratio, a vocal contingent says yes.

Why Microsoft Stock Went Up

It’s true that Microsoft has had ups and downs over its 40-plus year history, but as a company, it has been on a decided upswing for at least five years.

Share prices recovered from the March crash almost immediately, then proceeded to hit new highs in the months that followed. 

Aside from the fact that the company has been in a strong financial state for some time, Microsoft was uniquely positioned to realize benefits from the coronavirus economy. The move to virtual work, school, and entertainment was made possible by cloud technology, which is one of the areas in which Microsoft shines. 

The Microsoft Azure cloud platform is in high demand, and that’s just the beginning. Microsoft is also generating revenue with its X-Box Game Pass, a subscription for gaming services, which fills the need for more at-home entertainment options.

These, in addition to Microsoft’s other popular products, have pushed share prices up since the dip.

Microsoft Financials

There are very few companies that can boast a market cap of more than $1 trillion, but Microsoft passed that threshold back in 2019.

Today, the company’s value exceeds $1.6 trillion. At the time of our research, Microsoft stock had increased more than 36 percent, which exceeds total market growth by more than 26 percent. 

It’s true that 36 percent percent growth is less-than-impressive given Microsoft’s history but it’s extraordinary as an objective measurement when compared to the vast majority of companies.

That slowing growth might be a concern in any other year, but in 2020, it’s nothing to worry about. Considering the losses most businesses are currently experiencing, 36 percent is a strong number for this unusual year. 

From the start of 2018 through October 2020, its value has gone up by an astonishing 152 percent, handsomely rewarding long-term investors.

Microsoft reported results for the quarter ending September 30, 2020, on October 27th, and the news was nearly all good.

Total revenue came in at $37.2 billion, an increase of 12 percent year-over-year. Net income was a solid $13.9 billion – a 30 percent increase as compared to the same period in 2019.

The biggest gain came from the Intelligent Cloud division, which saw a 20 percent increase in revenue for the quarter. 

Is Microsoft Valuation Too High?

Some detractors believe that Microsoft’s valuation is too high when compared to its near-term earnings potential, but most analysts agree that the relatively expensive share prices appropriately reflect expectations for the company’s growth.

The company controls a number of successful divisions, and it owns some of the most advanced technology in the world. Better still, Microsoft continues to innovate and expand, which promises to keep it in an industry-leading position long-term.

More importantly, Microsoft is a leader among tech companies when it comes to maximizing profit margins.

It has demonstrated a remarkable ability to increase its margins quarter after quarter, in part because of the nature of the business.

Tech services lend themselves well to pulling more profit from each dollar of revenue, thanks to improving efficiencies and economies of scale.

Further, there is something to be said for Microsoft’s dividend yield, which is of particular interest to income investors. The company has made sharing profits with shareholders a priority, and no exception was made due to the market conditions in 2020.

Microsoft announced that 2020 dividends would increase by 9.8 percent in the midst of a long list of announcements that other companies planned to reduce or eliminate dividends altogether.

All of these factors taken together show Microsoft’s valuation is not too high. It might not be growing as quickly as certain tech startups, like Zoom (ZM) that catapulted to world renowned thanks to the migration to virtual meetings.

Nevertheless, it is growing consistently – and in a manner that can be sustained in the short-term and long-term. 

Will Microsoft Stock Drop?

Microsoft is a profit machine. And a deep dive into its financials shows that its fair market value is pinned at $218 per share – using a discounted cash flow forecast analysis. Prices above that will signal the share price is overvalued and potentially due a correction. 

Bargain hunters should keep Microsoft on their radars when prices fall meaningfully below this level. Any major market selloff could drag MSFT share price down and offer an opportunity to scoop up the tech giant at discounted prices.

With that said, Microsoft is as likely to have ups and downs as any other company. After all, external political and economic events tend to impact entire industries – and sometimes the full market – without exception. However, there is no reason to believe that Microsoft will experience a significant or sustained drop given the information available today. 

Unlike it’s tech peers, Microsoft isn’t the subject of government investigations, and it is in solid financial shape. The company can withstand tough economic times, particularly if they are pandemic-related. 

Is Microsoft Stock Overvalued? The Bottom Line

The bottom line is that Microsoft is expensive, but it isn’t overvalued. The current share price considers Microsoft’s success in the face of difficult economic times, as well as its prospects for continued growth in both the short-term and the long-term.

That, and the fact that Microsoft pays a healthy dividend, is reason enough to buy stock at the current price. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.