Some refer to Microsoft as the greatest stock in the world. I understand why some refer to Microsoft that way, as it is one of only two companies with an AAA credit rating (the other being Johnson & Johnson). Microsoft has delivered tremendous growth over the years, and its products are expected to remain in demand for years to come. The question is, is now the time to buy the stock? In this analysis, I will attempt to answer that question.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
For full disclosure, I should mention that at the time of writing this analysis, I do own Microsoft stocks. Microsoft currently represents 2,57% of my copy trading portfolio. If you would like to copy the portfolio or view the stocks I hold, you can find instructions on how to do so here. I view Microsoft as a long-term investment and do not anticipate closing my position in the near future. Despite being the owner of Microsoft, I will ensure that this analysis remains unbiased. If you want to purchase shares or fractional shares of Microsoft, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Microsoft is a multinational technology company based in the United States. It was founded by Bill Gates and Paul Allen in 1975 and is now one of the largest companies in the world. I will not delve into extensive details about the company, assuming that everyone is already familiar with it. However, it’s important to understand the various business segments within the company. Microsoft operates and reports its financial performance using the following business segments: Productivity and Business Processes (approximately 32% of revenue), Intelligent Cloud (approximately 43% of revenue), and More Personal Computing (approximately 25% of revenue). In short, the Productivity and Business Processes division includes Office 365, LinkedIn, and cloud-based applications. Intelligent Cloud includes Azure, as well as support and consulting services. More Personal Computing includes Windows, devices, gaming, and search advertising. Microsoft generates most of its revenue in the United States, with approximately 51% of its revenue coming from the U.S., while the remaining 49% is generated in the rest of the world. A substantial portion of Microsoft's revenue is recurring through its cloud services and subscription-based products. Regarding Microsoft's moat, I believe that they have several. The most obvious is the brand moat, as it is a well-known brand that consumers trust. Microsoft also has a strong switching moat, as switching to a competitor in most cases is not worth the hassle.
Their CEO is Satya Nadella. Before joining Microsoft in 1992, he worked at Sun Microsystems. He held several positions at Microsoft before becoming CEO in 2014 and Chairman of the Board in 2021. He has a BA in Electrical Engineering, an M.S. in Computer Science, and an MBA. Since becoming the CEO, he has transformed Microsoft's culture by emphasizing empathy, collaboration, and a growth mindset. He has often been described as an exceptional CEO who is highly regarded by his employees. One of Satya Nadella's most significant moves was shifting Microsoft's focus from a software-driven company (relying heavily on Windows and Office) to a cloud-first, mobile-first company. Under his leadership, Microsoft Azure became a major player in the cloud computing space, rivaling Amazon Web Services (AWS). This transition was key in revitalizing Microsoft’s growth, making it one of the top two cloud services providers globally. Satya Nadella hasn't been afraid of making large acquisitions either. Under his leadership, Microsoft has acquired LinkedIn for $26 billion, GitHub for $7,5 billion, and Activision Blizzard for $68 billion. According to Barrons, he has performed very well, as the stock has increased by more than 700% since he became CEO. Nearly 90% of Microsoft's current value has been generated under his leadership, making him one of the greatest value-generating corporate leaders of all time. His credentials inspire great faith in Satya Nadella's leadership, and I firmly believe that he is the ideal person to propel Microsoft's growth in the future.
Microsoft has a strong brand and switching moats. I really like the management too. Now, let us analyze the numbers to determine if Microsoft meets our criteria for having a strong moat. In case you want an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.
The first number we will look into is the return on invested capital, also known as ROIC. We require a 10-year history, and all years must have numbers above 10%. Microsoft has consistently delivered an impressive return on invested capital (ROIC) above 10% every year over the past decade. Microsoft has achieved a ROIC above 20% every year since 2019. The higher ROIC in 2019 and onwards is because 2019 marked the first year where a significant portion of Microsoft's revenue stemmed from its rapidly expanding cloud services. ROIC was above 30% in both 2021 and 2022 but dropped below 30% in both 2023 and 2024. The reason for ROIC decreasing in 2023 and 2024 is due to Microsoft ramping up its capital expenditures to expand its cloud services, enhancing data centers, and supporting other growth initiatives, which management believes will drive long-term growth. Thus, I'm not worried that ROIC has decreased slightly in the past two years.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Microsoft has had some years with decreasing equity, but since 2019, equity has grown every year. It is also worth noting that equity has grown by more than 10% year over year since 2019, which makes Microsoft a textbook example of how you would like to see a company grow its equity. This consistent growth in equity demonstrates strong financial health and a solid foundation for continued long-term success.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Not surprisingly, Microsoft has maintained positive free cash flow every year for the past 10 years. Microsoft has managed to increase its free cash flow every year in the past decade, except for fiscal year 2023. The reason free cash flow decreased in fiscal year 2023 was that Microsoft ramped up its capital expenditures to support its cloud services expansion and other growth initiatives. Despite continuing to increase capital expenditures, Microsoft delivered its highest free cash flow ever in fiscal year 2024, which is very encouraging. The levered free cash flow margin hasn't reached previous heights in the past two years, also due to the increased capital expenditures. The free cash flow yield is currently at its second-lowest level in the past decade, which indicates that the shares are trading at a premium, but this is something we will revisit later in the analysis.
Another important aspect to investigate is the level of debt, specifically whether a business has manageable debt that can be paid off within a period of 3 years. We do this by dividing the total long-term debt by earnings. After performing the calculation on Microsoft, I can see that the company has 0,48 years of earnings in debt, which is well below the three-year threshold. With a AAA credit rating, debt wasn't expected to be an issue, but it is still reassuring to see such a low level of debt.
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Obviously, Microsoft is a great company, and it will most likely continue to grow due to its innovation and strong competitive advantages. However, no investment is free from risk, and investing in Microsoft is no exception. One risk is competition. Microsoft faces significant competition across its product lines, particularly from major tech companies like Google, Amazon, and Apple, as well as smaller, specialized firms. The fast-paced nature of technological innovation requires Microsoft to continuously adapt and innovate. Failure to do so risks product obsolescence and market share loss. The company's reliance on platforms like Windows and Azure is challenged by rivals with strong ecosystems, such as iOS and Android. Competitors’ diverse business models, including free services and vertically integrated solutions, put pressure on Microsoft’s traditional licensing and cloud services, driving up costs and reducing margins. In cloud computing, intense competition from AWS and Google Cloud forces Microsoft to invest heavily in infrastructure and AI. The rise of mobile devices further threatens Microsoft's reliance on the PC market. If Microsoft cannot keep pace with innovation and ecosystem development, its financial performance and competitive position could suffer. Laws and regulations pose significant risks for Microsoft. Governments around the world, including the U.S., EU, China, and others, closely scrutinize Microsoft’s business practices under competition laws. For instance, Microsoft faces regulatory actions like the EU Digital Markets Act, which places restrictions on key products such as Windows and LinkedIn, limiting behaviors like self-preferencing and data use. This regulation could hinder Microsoft's ability to innovate or operate freely, reducing the competitiveness and attractiveness of its products. The company’s increasing involvement in AI development and cloud services brings additional scrutiny and regulatory risks, particularly around data privacy and security. Emerging laws like the EU's GDPR and potential AI regulations may force Microsoft to adjust its products, increase costs, and limit innovation in certain markets. The complexity of international regulations, varying interpretations by authorities, and the risk of fines or restrictions pose ongoing challenges that could lead to product modifications, delays, or withdrawal from certain markets, ultimately impacting Microsoft’s financial results and growth. Moreover, as Microsoft’s market dominance continues, the likelihood of future antitrust actions in the U.S. and abroad increases, which could lead to further operational restrictions and financial penalties. Macroeconomic conditions present significant risks for Microsoft, as adverse economic changes can directly impact consumer and business spending. During periods of economic downturn, such as inflation and recessions, IT budgets typically shrink, reducing demand for PCs, servers, and other devices that rely on Microsoft’s software. This decrease in demand can negatively affect the company’s sales and financial performance. Microsoft’s reliance on an extensive partner and retail network, including OEMs, adds to this risk. Economic difficulties or bankruptcies faced by key partners could disrupt sales channels, limiting product distribution and further impacting revenue. In difficult economic times, customers may struggle to pay for products and services, leading to an increase in defaults, higher allowances for doubtful accounts, and more write-offs of accounts receivable. Additionally, while Microsoft has weathered past economic crises better than the broader market, uncertainty around future economic conditions could affect cloud adoption or consumer demand for its products, making the company vulnerable to broader economic trends and fluctuations.
There are also plenty of reasons to invest in Microsoft. One reason is Artificial Intelligence (AI). AI is a major growth driver for Microsoft, much like its successful shift to cloud computing. Microsoft is investing heavily in AI, both financially and strategically, to maintain its leadership in this expanding area. Azure plays a key role, with AI innovations and global infrastructure supporting long-term growth. Azure's revenue growth, which included a significant 8-point boost from AI services, highlights the strong demand for AI that even exceeded Microsoft's available capacity. A standout product is Copilot, integrated into Microsoft 365, which boosts productivity and drives recurring revenue through its subscription model. Microsoft's AI focus also extends to developer tools like GitHub Copilot, while Power Platform and Dynamics 365 enable businesses to streamline operations. The company’s unified AI stack improves efficiency and margins as it scales, allowing for broad AI adoption. These strategic AI investments ensure Microsoft is well-positioned for sustained growth as AI reshapes industries globally. Cybersecurity, LinkedIn, and Search are key areas where Microsoft is making significant strides, and they offer compelling reasons to invest in the company. Grouped together, as Satya Nadella has expressed optimism about all three areas, they represent critical components of Microsoft's growth strategy. Microsoft has invested heavily in cybersecurity, now serving over 1,2 million customers, with its cloud security solution, Defender for Cloud, generating over $1 billion in revenue in the past year. As businesses increasingly prioritize digital security, Microsoft's strong product lineup and focus on monetizing its solutions position it well for future growth in this vital sector. LinkedIn continues to experience accelerated growth, with record engagement levels and a rise in content sharing. Its B2B digital advertising platform, LinkedIn Marketing Solutions, has solidified its leadership in the space, while LinkedIn Premium subscriptions have surged by 51% year-over-year, driven by new AI-powered tools that enhance user experience. This combination of user growth, engagement, and AI-powered features makes LinkedIn a valuable asset within Microsoft's portfolio. In Search and Advertising, Microsoft’s integration of AI into Bing, Edge, and Copilot has significantly boosted growth, with search and news advertising revenue up 19% year-over-year. AI-driven innovations like generative search have enhanced user experience, resulting in increased engagement. These advancements in cybersecurity, LinkedIn, and Search are positioning Microsoft to capture further growth in these important areas. Gaming is a strong reason to invest in Microsoft, with the company expanding its ecosystem and content offerings. Microsoft now has over 500 million monthly active users across devices, with Game Pass playing a key role by offering popular titles and enabling game streaming on multiple platforms, including Amazon Fire TVs. The subscription model, central to Microsoft’s strategy, generates recurring revenue, building a robust software annuity and subscription business that provides long-term financial stability. The Activision acquisition has significantly boosted gaming revenue, leading to a 44% overall increase and a 61% rise in Xbox content and services. This acquisition strengthens Microsoft’s presence across PC, console, and mobile gaming, adding valuable intellectual property (IP) like Call of Duty, which can be monetized across platforms, enhancing the company's revenue streams. Additionally, Microsoft’s investment in cloud gaming allows users to play games on various devices, expanding its reach to new audiences. With a strong content pipeline, expanded access to gaming platforms, and increasing subscription revenues, Microsoft is well-positioned for sustained long-term growth in the gaming industry.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 11,80, which is the one from fiscal 2023. I have selected a projected future EPS growth rate of 13,5%, which is in line with the analysts' consensus at Finbox. Additionally, I have chosen a projected future P/E ratio of 27, which is twice the growth rate. This decision is based on the fact that Microsoft has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $279,40. We want to have a safety margin of 50%, so we will divide it by 2. This means that we want to buy Microsoft at a price of $139,70 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 118.548 and capital expenditures were 44.477. I attempted to review their annual report to determine the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 31.134 in our calculations. The tax provision was 19.651. We have 7.434 outstanding shares. Hence, the calculation will be as follows: (118.548– 31.134 + 19.651) / 7.434 x 10 = $144,02 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Microsoft's Free Cash Flow Per Share at $9,97 and a growth rate of 13,5%, if you want to recoup your investment in 8 years, the Payback Time price is $147,03.
I believe that Microsoft is a great company with excellent management. The company has consistently delivered a high ROIC and increased its free cash flow in every year of the past decade except for one. I also appreciate that Microsoft is one of the only two companies with an AAA credit rating. However, competition is a risk for Microsoft, as it faces strong rivals like Google, Amazon, and Apple, as well as smaller firms, across its key product lines. The fast pace of technological innovation requires constant adaptation, and competitors’ diverse business models—such as free services and vertically integrated solutions—put pressure on Microsoft's traditional revenue streams. Laws and regulations also pose a risk for Microsoft as global scrutiny, especially under competition laws, can restrict its ability to innovate and operate freely. Emerging regulations in areas like data privacy, AI, and cloud services may increase costs, limit product development, and potentially lead to fines or market restrictions. Macroeconomic factors are another risk, as economic downturns, such as inflation or recessions, can reduce consumer and business spending on IT products, negatively impacting Microsoft’s sales. On the upside, AI is a major growth driver for Microsoft, with substantial investments in AI across platforms like Azure and products such as Copilot, which boost productivity and drive recurring revenue. Microsoft’s unified AI stack, integrated across tools like GitHub Copilot, Power Platform, and Dynamics 365, enhances efficiency and positions the company for long-term growth as AI adoption accelerates globally. In addition to AI, cybersecurity, LinkedIn, and Search are strong reasons to invest in Microsoft, as the company has seen significant growth in all three areas. Gaming is another compelling reason to invest in Microsoft, with over 500 million active users and a growing subscription model through Game Pass that generates recurring revenue. The Activision acquisition has significantly boosted gaming revenue and expanded Microsoft's presence across PC, console, and mobile platforms. In conclusion, I believe that Microsoft is one of the best stocks to own. If I could only own one stock in my portfolio, it would probably be Microsoft. Therefore, I believe that buying shares at the intrinsic value of the Payback Time price of $294 would make a great investment.
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