Microsoft’s (NASDAQ:MSFT) post-earnings rally and fade is likely due to Nasdaq’s rising volatility. Investors cannot decide if they should bargain hunt and buy beat-up technology stocks or buy MSFT stock.
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As inflation pressures force central banks to raise interest rates faster than expected, technology investors should consider accumulating Microsoft stock.
Buy MSFT Stock After Strong Earnings And Guidance
Investors rushed to buy Microsoft stock after it reported earnings of $2.48 a share on $51.7 billion in revenue, up by 20% year-on-year. For its size, this is an incredible growth rate. Azure, its cloud business, enjoyed revenue growing by 46% Y/Y.
Thanks to Office 365, which faces almost no real competition, Microsoft’s Productivity and Business Process unit accounted for $15.9 billion in revenue, up by 19% Y/Y.
For the third quarter, Microsoft expects revenue in the range of $48.5 billion to $49.3 billion. The software giant is not only recession-proof but has a simple growth plan. In the gaming and metaverse space, the company will spend $68.7 billion to buy Activision (NASDAQ:ATVI). The deal will widen its lead over the competition. For example, Sony (NYSE:SONY) responded to the MSFT/ATVI deal by buying Bungie for $3.6 billion.
Sony’s deal does not give it much of an edge. The game studio’s hot title, Destiny, will not become an exclusive title on the Sony PlayStation platform. It will run on Microsoft’s Xbox as well.
Compared to Meta Platforms (NASDAQ:FB), previously known as Facebook, Microsoft’s Activision buy is relatively small. Meta expects the Facebook site will lose daily active users in the year ahead. It intends to spend over $90 billion a year to build the Meta Platform. This is a 10-15 year effort that is far from guaranteed.
Chief Executive Officer Satya Nadella said that owning Activision Blizzard will enable people to play “wherever, whenever and however they want, and also shape what comes next for gaming as platforms like the metaverse develop.” This strategy worked well for Microsoft’s mobile and desktop apps. For example, Teams works on multiple platforms, from personal computers to mobile devices. Office 365 is also cross-platform.
In the last quarter, Microsoft recorded more than 25 million Game Pass subscribers across PC and console. On the productivity front, Office 365 commercial revenue grew by 19%. It reported installed base expansion across all customer segments. The average revenue per user also rose. ARPU will also rise again after Microsoft raises subscription fees.
Office consumer revenue grew by slightly slower than commercial, up by 15% Y/Y.
LinkedIn continued to grow meaningfully. Revenue increased by 37% Y/Y. This is due to strong results from Marketing Solutions, which grew by 43% Y/Y. Talent Solutions performed better than Microsoft expected.
With PC hardware, the company posted revenue of $17.5 billion. Personal Computing benefited from strong Surface computer sales. Windows OEM also lifted the unit’s growth.
Investors seeking exposure to the PC market at a steeper discount have other options. Storage supplier Western Digital (NASDAQ:WDC) slumped to below $50 after posting quarterly results on Jan. 27, 2021. The stock trades at a price-to-earnings in the high single digits. HP Inc. (NYSE:HPQ) and Dell (NYSE:DELL) also trade at a similar P/E multiple.
Corsair Gaming (NASDAQ:CRSR), is a high-end gaming supplier. Since its initial public offering over a year ago, the stock traded in a sustained downtrend. CRSR stock is twice as expensive as that of HPQ and DELL stock. As such, its turnaround is not a sure thing.
On Wall Street, not a single analyst rated MSFT stock lower than a “buy” rating. Based on 28 analysts giving stock ratings in the last three months, the average price target is $375 (per Tipranks).
The cautious investor may forecast a deceleration in growth within the next five years. Assume that competition in the gaming industry heats up. Furthermore, Microsoft will become too big that it cannot repeat past revenue growth. In this scenario, Microsoft shares are worth around $320.
This five-year discounted cash flow EBITDA Exit finbox model applies reasonable metrics shown below.
|Discount Rate||7.3% – 6.3%||6.80%|
|Terminal EBITDA Multiple||21.2x – 23.2x||22.2x|
|Fair Value||$299.87 – $335.36||$317.30|
At a 22.2x multiple and a discount rate of below 7%, Microsoft stock trades at close to fair value. Readers willing to apply a lower discount rate and higher terminal EBITDA multiple will get a higher fair value target.
The Bottom Line
The lockdown in the last two years forced people to stay at home. This could have accelerated demand for PCs and lifting gaming sales higher. With the world getting ready to live with the coronavirus, Microsoft’s software and gaming hardware sales may slow.
Microsoft stock may need its valuation reset slightly lower to account for the potential slowdown risk. If the stock falls by another 10-15%, its discount to fair value rises. Value investors looking for exposure to the technology sector should not hesitate to consider MSFT stock.
So far, it showed no signs of slowing down. It raised its quarterly guidance and may do so again a few times this year.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.