What Stock Could Be the Next Microsoft?

Microsoft (NASDAQ:MSFT) is one of the best investments of the past several decades. $1,000 invested in MSFT shares when the company went public in 1986 would be worth over $3.9 million today.

But what other success stories of today have the potential to rival Bill Gates’s company over the next few decades?

What Made Microsoft Special in the First Place?

Before trying to find the next MSFT, it’s worth spending a moment looking at just why Microsoft has achieved such lofty heights.

A key component of Microsoft’s success was its policy of aggressive expansion into new, high-margin areas of technology. Long after establishing itself as the world’s largest software maker, Microsoft staked a claim in the cloud computing world. Both of these business lines offer high margins, allowing Microsoft to become incredibly profitable.

The other piece of the puzzle that helped put Microsoft over the top was its careful financial management. The company has been steadily reducing its debts since 2018, all the while building up a massive stockpile of cash that it can invest in partnerships, acquisitions and new growth initiatives. As of the most recent quarterly report, this reserve totaled over $81 billion.

With the cloud computing space already essentially full, the next obvious areas of technological progress will be the fields of AI and advanced IT security and monitoring.

These areas are currently filled with companies that have the potential to establish Microsoft-like moats, though investors should understand that these companies are likely to be high-risk, high-reward ventures.

Palantir

Data analytics company Palantir (NYSE:PLTR) has the potential to become the Microsoft of the AI world. While there is no lack of competition among AI companies, Palantir may be uniquely positioned to rise to the top of this emerging market.

To begin with, the Palantir team has deep experience with data analytics for government entities, giving it both know-how and a stable of long-term contracts.

Palantir also has some of the largest companies in the world, notably 3M and BP, as customers on its commercial side.

The CEO famously entered the AI space long before most people really understood what artificial intelligence was, let alone its capabilities.

One effort in this area is its so-called AI bootcamp concept. With this program, companies can try out Palantir’s AI platform before actually paying for it. This lets Palantir generate leads and show off uses for its technology. Though the concept is a fairly new one, it’s likely to produce strong sales growth for Palantir going forward.

Palantir’s strategy is already showing early signs of success. 2023 was Palantir’s first profitable year and saw the company bring in a net income of $210 million.

Revenue growth has been very respectable with total sales rising by 20% year-over-year in Q4. A particularly bright spot has been a 32% growth in commercial revenues. This progress on the commercial side of the business is crucial as it may eventually help the firm reduce its reliance on government contracts.

Palantir has also managed its finances tightly, keeping a zero debt-to-equity ratio. Palantir’s cash reserve stands at $3.7 billion, more than half its trailing 12-month sales of $2.2 billion.

As with Microsoft, these cash holdings can help Palantir drive growth by investing in new initiatives without the dragging effect of debt.

On the downside, Palantir trades at a price that may not accommodate missteps when it comes to earnings growth. The stock is priced at 132x forward earnings, 21x sales and 229x cash flow.

Even for a company with a growth runway as promising as Palantir’s, these metrics strongly indicate overvaluation. This conclusion is supported even further by the price-to-earnings-growth ratio of 5.4. For reference, PEG multiples over 2.0 are generally seen as strong indicators of a growth stock being overvalued.

Datadog

Datadog (NASDAQ:DDOG) is another technology company with Microsoft-like qualities. Where Palantir has expanded into AI, though, Datadog has made its mark by creating monitoring tools for cloud-based apps and other IT service needs.

Like Palantir, Datadog shares are priced at lofty multiples. DDOG shares trade at 19.5x sales, 88x forward earnings and 320x cash flow.

The company’s PEG ratio is, amazingly, even higher than Palantir’s at 10.3x projected earnings growth.

While the two companies both trade at sky-high multiples, Datadog may actually be the better value between them.

The reasons for this is that Datadog has created an entire ecosystem of tools that can be used by a wide variety of businesses. As such, customers who originally come to Datadog for a single tool often end up using several of the company’s offerings and Datadog is able to maximize value from its client base.

This approach to maximizing customer value can be seen directly in the company’s results. As of the end of 2023, Datadog had 396 customers contributing revenues of $1 million or more annually. This trend of high-dollar customer development also contributed to the company’s 26% year-over-year revenue growth in Q4.

Another point in Datadog’s favor is its massive addressable market. By 2026, the company’s TAM is likely to be over $60 billion, which creates conditions for sustained double-digit revenue growth and strong long-term earnings growth.

Over the coming five years, for example, analysts forecast Datadog to continue raising earnings by about 15.8% annually.

As with Palantir, Datadog carries a fair risk of being significantly overvalued. The company’s approach of expanding its tool portfolio also raises its competition risks over time.

While Datadog has little direct competition in cloud monitoring, its other tools have crossover with much larger companies like Amazon and Microsoft against whom it may struggle to compete.

A final factor investors should be aware of when it comes to Datadog is the fact that the company has diluted its shares considerably to keep its cash position strong.

In 2023, the number of outstanding shares increased by more than 11%, reducing the ownership stakes of existing shareholders. If management continues to issue new shares, investors are likely to see the value of their existing holdings erode as the market prices in the dilution of the new share offerings.