On the Dip, Microsoft Looks Like a Solid Pick Once Again

• Despite a 30% decline from the highs, Microsoft stock still looks somewhat expensive
• But the company is managing through a slump in PC sales; the long-term outlook remains solid
• Sheer size limits the upside, but with lower risk, MSFT stock is attractive here

At this point, no investor is going to get rich off Microsoft (NASDAQ:MSFT) stock — at least, not quickly. With a market capitalization of $1.82 billion, the Redmond, Washington-based giant simply is too large and too mature to post stunning multi-year returns. 

But, particularly with a 30% decline from last year’s highs, MSFT is precisely the kind of stock that long-term investors should own to add wealth consistently. It remains one of the best — maybe the best — businesses out there. Valuation is not necessarily cheap even after the sell-off, but in the context of growth potential and near-term headwinds, it’s certainly reasonable. All told, there’s enough here to like.

A Difficult 2023?

Wall Street views on MSFT seem to highlight a bit of a contradiction. The average price target on the stock sits at $297, suggesting a 23% upside (plus another 1%-plus in dividends). Yet the consensus outlook for earnings per share in fiscal 2023 (ending June) suggests growth of less than 4% year-over-year, a notable deceleration from the 16% increase posted in fiscal 2022.

In other words, analysts believe MSFT should trade at about 31x earnings — even though those earnings are barely expected to grow at all. (In fact, a chunk of what growth Microsoft is expected to drive comes from share repurchases rather than increased profits from the operating business.) 

It seems strange to be so bullish on the company ahead of such a difficult year. And, indeed, it’s likely to be a difficult year: Microsoft management admitted as much on the fiscal first quarter conference call back in late October.

The company is simply facing a series of challenges. The strong dollar is providing a headwind: currency took five full percentage points off the revenue growth rate in the most recent quarter and cut nine points off the increase in operating profit. 

Microsoft benefited from the pandemic-driven boom in sales of personal computers; that tailwind is reversing, with Windows revenue from PC sales down 15% year-over-year in fiscal Q1. And in the enterprise market, customers are tightening their belts, providing another potential brake on overall growth. 

Wall Street’s caution toward FY23 earnings, at least, seems logical. To some investors, its optimism toward Microsoft stock might not make nearly as much sense.

The Long-Term Case

But the Street’s outlook actually does make sense — and perhaps even highlights the opportunity here. FY23 is going to be a difficult year for Microsoft, particularly in the context of its impressive turnaround over the past decade. What’s important, however, is that it’s going to be a difficult year because of the external environment, not because of any failings in the business, competitive problems, or other factors.

Whatever the actual bottom-line growth rate this year, the business is in fine shape. In the cloud space, Azure continues to chase down Amazon.com (NASDAQ:AMZN) in the bid for top market share, and Microsoft seems to have distanced itself from the likes of Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG), and Oracle (NYSE:ORCL).

Windows and Office still have essentially no competition. Even Bing appears to be taking market share, though Google still dominates the search market.

Meanwhile, the challenges in the external environment are going to come to an end. The dollar will stabilize. PC sales likely return to their admittedly modest long-term growth rate. How the macro environment shakes out is anyone’s guess, but over time it will even out.

The point is that the stock market — and yes, most stock analysts — are forward-looking. For Microsoft, it’s not only about results for fiscal 2023 but the outlook for fiscal 2026 and fiscal 2033. 

That outlook hasn’t really changed. The only thing that has is the price. Long-term, those are both good things.

Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.