MSFT Research Notes

Good morning Stonk Science squad! I've been asked by many of my friends if it's a good time to buy the (M)MAGA stonks (formerly FAANG) now that most of them have halved in value. Instead of giving them a direct answer, I decided to drill down on some high-level, big-picture, 20,000-foot granular details on each company and share my opinion here. I put pencil to paper, without boiling the ocean (obviously), but really think this analysis will help you sink the putt with your MD when they ask you what's going on with stonk markets. 

Without further adieu, Microsoft....

Price: $89.09

Microsoft has taken a hit, just like most other large companies. Their price has fallen by almost $100 per share since January; that’s good for a ~30% decrease on your investment if you’re a buy-high, sell-low type of investor. The S&P 500’s dropped ~16% YTD, so you can do the math on how much MSFT has underperformed. A bit of a yikers, but they're actually doing well relative to the other stonks in the MAGA group.

Technicals: Meh

I’m only a fan of technical analysis when I feel like day trading without doing any analysis, which is never, but decided to include it for all my friends who like to say things like this: “I should have bought *fill in stock name* on *fill in date when stock XYZ hit its recent lows*”. RSI and MACD are my indicators of choice; unless you actually like drawing triangles or the teeth of alligators on your stock charts, MACD and RSI are the most helpful. I mean, at the end of the day, I've only passed three levels of the CFA, so what do I really know anyways?

If you’re looking from a technical perspective, MSFT was oversold in November, making that a good time to buy from a technicals perspective. If you’ll recall, this is when 10-yr bonds peaked at ~4.2% and when markets *thought* the economy was destined for perpetual economic turmoil (i.e. everything isn't going go back to normal immediately). You’ll see this story throughout this MEMEmail series, so if you’re a big technicals guy or gal, November was the time to buy almost all of these.

Financials: Oh wow... *grins while reading through financial statements*

Wow… Microsoft’s financials (as of FY 6/2022) are EXCELlent (you’re welcome).

Let’s break it down:

Intelligent Cloud (38.0% of total revenue)

"Oh my goodness, where are all my pictures??"

"They’re on the ✨cloud✨, mom."

Cloud products, such as Azure, had growth of 45% - I guess my mom isn’t the only one to transition to the ✨cloud✨. Server product growth increased by only 5%, while enterprise services increased by 7%.

I’m not worried about the lower growth of cloud services and server products, because the margins here are V strong (44%) and, at the end of the day, leaving your cloud storage provider is more painful than leaving your girlfriend. If you leave your girlfriend, at least you’d have pictures to remind you of her, but turning off cloud storage means you can’t access the 50 versions of the model that you’ve been working on for your MD for the last month. That’d be a big oof. I would know...

Productivity and Business Services (32.0% of total revenue)

All your favorite Office products, as well as LinkedIn, are included in this. Do you think your senior associate is going to want to pivot from Excel and Powerpoint to power BI when your top client gives you a sell-side mandate that could lead to millions in fees?

You, me, and Microsoft know that’s a hard no. Even if they did switch, Microsoft owns Power BI anyways, so they’d still be making money. What makes Microsoft different between you and me is that Microsoft charges a premium for knowing you won't switch - as in they are making a 47% margin on their office products. In fact, Office products are so entrenched in the business space that MSFT has decided that they can increase their margins from 38% to 47% over the last year. Oof. Maybe you’re going to need to learn how to do more than the SUM function in excel to make your company’s investment pay off.

You’re wondering why I haven’t mentioned LinkedIn? Oh, well it’s still the world’s #1 dating site and has grown by 34% over the last year because, as you know, every company is looking for that special someone to punch numbers into an excel template this year.

Personal Computing (30.1% of total revenue)

Operating systems, Xbox, and search advertising revenues have grown 10% YoY. Also, surprise, Bing! is still relevant enough to grow 25% (that led to increased revenue of $2.3B from advertising spend); I guess advertisers pay a premium to sell stuff to people who don’t know how to change their default web browser… Interesting.

Despite the strong growth and healthy margins, I’m skeptical of this segment going forward, as video games and advertising spending are especially susceptible to changing economic environments and lower consumer net disposable income. Microsoft is also caught up in a legal battle for Activision-Blizzard, which will cost a pretty penny in legal fees, though winning could mean larger margins and more recurring revenue.

Innovation

For any company, creating and maintaining a competitive advantage is critical to long-term success. If you don't believe me, read Zero To One by Peter Thiel. If you don't believe me, then just reflect on Kodak, Nokia, and BlockBuster.

"Who are they?" Exactly.

After relentlessly Ctrl + F’ing my way through MSFT’s 401K, it is apparent MSFT is seeking to innovate two areas:

1. AI (same bro) - Making access to AI-enabled products easier for the consumer.

2. Gaming – "Pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment". Pretty sure that’s a corporate way of just saying virtual reality, but it’s cool. I deal with corporate jargon all the time, so it's all good.

Both goals are ambitious, as they will transform how people interact with excel and their Xbox, plus MSFT is investing in R&D and have entire centers of research dedicated to innovation. TBH, though, I’d like for them to put their money where their mouth is, as they are paying 3x their annual R&D spend to *maybe* acquire Activision-Blizzard.

Valuation

If you know me well, you know I’m a big valuation guy, and Microsoft’s valuation is looking about appropriate for a late-stage technology company turned conglomerate that has lower forecasted earnings growth. What makes this a curious case, however, is that growth and return expectations are still strong, as noted by forward EPS growth. I’m typically skeptical of forward estimates, but it looks like MSFT is trading at a discount relative to its historical valuations thanks to a sharp contraction in valuation multiples (thanks Mr. Jerome). How about that - growth at a (kinda) reasonable price! Yay.

Leverage: What leverage?

They have $77B in debt and $107B in cash. With an almost $2T market cap, I think they’ll be ok.

If you’re still worried, here are some pretty ratios to settle your worries.

Recommendation: She’s great, but I’m just not ready for something serious yet...

Margins: very nice. Growth: very consistent. Valuation: somewhere between appropriate and cheap. Leverage: little to none. That checks a lot of my boxes…

“But Mr. Stonk Scientist, what else are you waiting for????”

I can’t, in good conscience, give this stonk a buy rating knowing that the Fed is going to keep raising rates, causing its price to potentially fall even further. I like the company more than I thought, but risk premiums are rising fast and I want to be compensated for holding a risk asset in this environment. 

MSFT is like a really nice item during a Black Friday sale. It's great and I'd like to buy it, but I think it'll have a larger discount on Cyber Monday. I think the *metaphorical* Cyber Monday is coming soon...