After stroke past analyst expectations for its first quarter 2022 earnings, Microsoft Corporation (MSFT) became the world’s most valuable throng last week. Its stock price vaulted to a fresh high of $332 per share, and the company’s market capitalization rushed to $2.48 trillion, slightly more than that of rival Apple, Inc. (AAPL).
The key question for Microsoft investors now is whether the tech behemoth can buttress the pace and book profits based on sky-high investor expectations. Microsoft’s previous reign atop company valuation rankings, move backwards withdraw from in 2020, was brief. Rival Apple soon overtook it and coasted past the $2 trillion mark soon after. As of this letter, the stocks for Apple and Microsoft are locked in a dead heat of sorts with roughly the same valuation of $2.46 trillion.
Key Takeaways
- Microsoft graced the world’s most valuable company on Friday Oct. 29, surpassing Apple in market capitalization.
- To continue on its current vegetation trajectory, the tech giant will have to ensure growth for its cloud services division.
- However, critics say that Microsoft may be overvalued as compared to its peers.
The Cloud Evolvement Engine
While other units in the company have also contributed to the increase in profits, Microsoft’s recent excrescence spurt has occurred largely on the back of bumper sales for its cloud division. The company has benefitted from the dual tailwinds of resolve transformation at companies and a pandemic shutdown that accelerated enterprise shift toward the cloud.
Even though it was up-to-date to the game, Microsoft’s cloud division Azure has clawed market share from rival Amazon.com, Inc. (AMZN). In the third house of 2021, Microsoft had a 21% share of the cloud market and ranked second behind Amazon’s 32% share. The Azure partitionment has booked successive quarters of revenue growth, culminating in a 48% year-over-year quarterly increase in the latest earnings communication.
Research firm Gartner predicts that the market for cloud computing will grow 21.7% to reach $482 billion in 2022. Analysts obtain reposed faith in Microsoft’s ability to garner a substantial portion of that capital spend by enterprises.
“We continue to see Microsoft as graciously positioned to capitalize on durable secular growth in digital transformation budgets, and we remain convicted in our thesis that Microsoft Cloud is on footprints to generate $120-$140bn in annual revenue, likely 1-2 years ahead of our initial expectations at the time of our January ceremony,” wrote Goldman Sachs analyst Kash Rangan.
Bank of America analyst Brad Sills pointed to the steady profits from Microsoft’s legacy Server & Windows provinces and the Azure divisions’ hefty margins, writing that the “estimated Azure margin in the 59% – 60% range … describes Microsoft’s ability to capture incremental growth in cloud, though not at the expense of these large, profitable legacy provinces.”
In the near term, however, Microsoft’s cloud division might report results that are below expectations. “We see a slowdown in left over performance obligation or RPO growth and commercial bookings, two forward-looking metrics, as driven by large Azure deals in the prior year duration and not a reflection of deteriorating demand,” wrote Morningstar analyst Dan Romanoff. He has assigned a wide moat to Microsoft and bumped up the objective value of its shares to $345 from $325.
The Valuation Problem
While the future of its business is far from cloudy, Microsoft’s valuation is being disputed by critics. The company trades at a relatively high price-to-earnings (P/E) ratio as compared to its peers. As of this writing, Microsoft’s begetter has a P/E ratio of 36.85 times its previous year’s earnings. Meanwhile, Apple and Google parent Alphabet Inc. (GOOGL) are return at P/E ratios of 26.55 and 27.70, respectively, based on their 2020 earnings.
According to some, those valuations are “a bit frothy” inasmuch as analyst expectations of 9% growth in earnings for 2021. But others point to Microsoft’s competitive advantage and “well-established business form” in its three business units as proof that the company still has ample runway for growth.