Home Latest Microsoft Stock: Undervalued Based On Future Growth Prospects (NASDAQ:MSFT) – Seeking Alpha

Microsoft Stock: Undervalued Based On Future Growth Prospects (NASDAQ:MSFT) – Seeking Alpha

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Contrary to what many investors’ intuition may lead them to believe, Microsoft (NASDAQ:MSFT) stock does not appear to be overvalued. In fact, as you will see below, I think the stock is relatively undervalued under these market conditions. The company has a considerable competitive advantage and a well-established business model that generates enormous amounts of cash. Let’s explore the various points that led me to this conclusion.
Microsoft generates revenues from three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The chart below shows each segment’s weight in percentages.
Microsoft segment revenue
Source: Data retrieved from Microsoft financial statements
As it is evident from the chart, Microsoft’s revenue distribution is even across all three segments, which speaks of a well-diversified portfolio.
The personal computing segment saw an increase of 12% in revenues. This segment has to do with Windows OEM licensing related to new PC sales, online gaming subscriptions, Xbox content and hardware, search engine advertising, and to a lesser degree from the company’s own line of computers known as Surface.
The Azure intelligent cloud segment’s revenues increased by a staggering 24%, taking second place with a market share of 22%, second to Amazon’s AWS (AMZN) 32% market share, and ahead of Google (GOOG) (GOOGL) with only 8%. This is quite promising for Microsoft in the future as it takes advantage of the compounding effect of the cloud market share growth, especially considering an ever-increasing remote world.
The revenues increased overall by 16% on products such as Office 365 Commercial and cloud services on the productivity segment. Office 365 consumer products revenue saw an increase of 22% compared to the prior year, to a total of roughly 52 million subscribers, barely scratching the surface. The highly popular Office Suite has been mainly in the form of buying the licensing of the bundled software up until this point. However, with the introduction of Office 365 subscription-based software, end-users can take advantage of affordable monthly fees and continuous free updates and upgrades that previously required a licence. Personally, I find the Office 365 subscription very convenient for a series of products I have been using from a young age.
Similar to the segment revenues, the operating income is equally distributed among all three segments, as depicted in the chart below.
Microsoft segments operating income
Source: Data retrieved from Microsoft financial statements
Revenues have been steadily increasing YoY, and so has the bottom line. The chart comparison below between revenue and net income suggests that Microsoft can do a lot more on reducing its overall expenses, considerably increasing the net income in the years to come without requiring a similar increase in revenue.
Microsoft revenue and net income
Source: Data retrieved from Morningstar
Earnings per share have also sharply increased over the previous decade, and so have the dividends.
Microsoft EPS and dividend
Source: Data retrieved from Morningstar
The chart above is exactly what an investor wants to see in a company, and Microsoft does not disappoint. As I said earlier, there is a lot of room for Microsoft to grow its EPS even without exerting excessive efforts in increasing its revenues.
The operating margin is quite decent at around 40% and has been steadily increasing from the troughs in 2016-2017, which were mainly due to increased R&D expenditures. This is a clear indication of a wide economic moat Microsoft enjoys as a well-established tech giant. Gross margin is also consistently high between 65% and 70%, given the numerous data centers, extensive service and product support, manufacturing and distribution centers, warranties, inventory valuations and more, which are part of the cost of revenue.
Microsoft operating margins
Source: Data retrieved from Morningstar
The three return ratios are excellent, especially the sharp increase in the RoE ratio close to 50%, while the financial leverage has been steadily decreasing, as we will see below.
Microsoft ROE, ROIC, ROA
Source: Data retrieved from Morningstar
The company is generating enormous free cash flows in an upwards trend, which will come in handy in the future years as Microsoft invests in the research and developments of new technologies, critical to maintaining its competitive advantage.
Microsoft Free Cash Flow
Source: Data retrieved from Morningstar
Now take a look at the graph below displaying a constantly decreasing financial leverage and debt-to-equity ratio. I think this is an essential factor that puts any investor’s concerns of a rise in interest rates at ease. It seems Microsoft has been deliberately positioning itself ahead of the curve of a sharply increasing probability of higher interest rates. The company has been steadily deleveraging by reducing its debt by around 6% in 2021 alone, down to $63 billion as of this June from $67 billion in June 2020. The company is expected to pay off over $8 billion of debt in 2022 and anywhere from $2 to $5 billion each year until 2026. Nothing is concerning here as the company has plenty of cash reserves and generates enough FCF to cover these debt repayments easily.
Microsoft leverage and debt
Source: Data retrieved from Morningstar
The current and quick ratios have a value of around 2, which means the company has no liquidity issues.
MSFT current and quick ratios
Source: Data retrieved from Morningstar
Microsoft’s Windows operating system market share is around 75%, with OS X at only 16%. From 2015 onwards, Microsoft has allowed all existing windows PC users to upgrade to Windows 10, and now Windows 11, for free, thus solidifying its end-user base. Both Windows 11 and its predecessor are based on feature updates and upgrades, which are all included for free.
This turned out to be a great long-term strategy in that it prevented a lot of Windows users from jumping ship to another operating system platform. As a result, Microsoft has enjoyed an ever-increasing subscription to many of its digital services from consumer to commercial customers.
Given the vast market share for Windows-based PCs, this is unlikely to change anytime soon. Personally, I have always wanted to move from Windows to a Mac PC but have found it impossible to do so due to the lack of software support for many work-related tasks I need to do daily.
Naturally, just like every other tech firm, Microsoft is not immune to many risks it faces. Some risk factors include increased competition from different platform-based ecosystems, its business model, investment in products and technologies that may not achieve the desired returns, cybersecurity attacks, legal and regulatory risks, and more.
According to its annual report, Microsoft has a share repurchase program in place, and, together with its dividend payment, the company has returned to its shareholders around $10 billion in the fourth quarter of 2021 alone.
Valuation – Discounted Cash Flow Model
Assumptions for Microsoft
Current Stock Price
$331
Shares Outstanding
7.5 billion
Next year FCF (25% increase YoY)
$60 billion
Perpetuity Growth Rate
3%
Discount Rate (using a 10% historical average market return)
8%
Source: Own calculations
By discounting the future cash flows at 8% annually, the model returns a share value of $474, which makes the shares currently around 43% undervalued.
Other assumptions I have made are an average FCF increase of 25% over the next five years, which I think is reasonable based on the current trend. For value investors who insist on buying only at a certain margin of safety, I have used 33% for such calculation. The result is that Microsoft’s share price is fairly valued or just around 5% overvalued. However, short of a market collapse, it is not likely that Microsoft shares will fall by 33% anytime soon for them to be attractive to any die-hard value investor.
MSFT stock technical outlook
Source: TradingView, Microsoft monthly chart
Here is the only indicator you will ever need: the price – that and maybe a couple of averages just for reference. I don’t think there is much to see in this chart, and yes, I use a logarithmic scale. It looks as though the trend may be steepening, but I think there is quite a bit more room for it to run. One can see that even what in the past seemed like large fluctuations – March 2020 is a notable one – are nothing but minor blips in the bigger picture. Also, the volume is dropping, which is another indication that the trend is nowhere near the top.
Microsoft stock is, in my opinion, still relatively undervalued, even at what seems like historical highs. If this is the final phase of the long-term trend (probably lasting a few more years), which usually resembles a rocket launch, then it should not be difficult to see Microsoft double or even triple in the next two years. Of course, that would likely make it highly overvalued at that point, but markets are not known for self-control and very frequently shoot too far in one direction. That’s just my opinion, of course, and you be the judge. I am long Microsoft.
Thank you for your time.
(Please keep in mind that I frequently change my opinion in the face of new information or market conditions and, as a result, may also change my position in the stock.)
This article was written by
Disclosure: I/we have a beneficial long position in the shares of MSFT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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A casual guy with no definite plans for the day, he enjoys life to the fullest. He has a big passion for Linux, open source, gaming and blogging. He believes that the world is an awesome place and we’re here to enjoy it! He hails from New Delhi and has studied Journalism from Delhi University. You can reach him at sameep@thehoopsnews.com.