Is Microsoft stock overvalued or undervalued? Buy this dip and load (NASDAQ:MSFT)

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Investment thesis

Microsoft Corporation (MSFT) stock fell about 15% from its all-time high, following the correction in SaaS stocks. But, MSFT is a strong stock. The company is also extremely profitable and benefits from several age-old cloud computing growth engines. It is also rapidly expanding its Cloud SaaS capabilities, complementing its strength as the second hyperscaler behind AWS (AMZN). It also reinforced its lack of customer interface with its recent $69 billion deal to subsume Activision’s valuable gaming intellectual property (ATVI).

The deal will also include ATVI’s 400 million massive active users. We explained in our previous articles that the metaverse begins with the game. So the “game verse” is already there. Microsoft has indeed acknowledged this as CEO Satya Nadella alluded to recently (edited):

You and I will soon be sitting on a conference room table with our avatars or holograms or even 2D surfaces with surround sound. Guess what? The place where we’ve been doing this forever…is the game.” (FinancialTimes)

MSFT stock is certainly not immune to volatility due to the Russian military operation in Ukraine. However, we think long-term investors should capitalize on the volatility to add long-term leaders like Microsoft stocks. Investors should happily seize opportunities like this, and we encourage investors to load. We discuss more below.

Is Microsoft stock overvalued now?

Consensus price targets for MSFT shares Vs. stock market performance

Consensus price targets for MSFT shares Vs. stock market performance (TIKR)

Based on our fair value estimates, the MSFT share is now back in its fair value zone (+/- 10% compared to our fair value estimates). We therefore believe that Microsoft shares are reasonably valued. In addition, consensus price targets are also hugely supportive of Microsoft stock valuation (note that our implied fair value estimates are different from Street’s price targets).

Readers can glean from the chart above and observe that MSFT stock is now trading below its most conservative consensus price targets (PT). Plus, 44 of Street’s top analysts cover MSFT stocks, so they’re heavily covered. Therefore, we believe that consensus PTs are reliable. The only time MSFT stock crashed well below its most conservative PTs was during the COVID-19 bear market.

However, as we explained earlier, such short-term volatility is impossible to predict. But it didn’t matter that investors had a long-term perspective. The table above illustrates very clearly what we meant.

How does MSFT’s assessment compare to its peers?

MSFT share EV/NTM EBITDA vs.  peers

MSFT share EV/NTM EBITDA vs. peers (TIKR)

We can glean from the above that MSFT shares are trading at a premium to its mega-tech peers. For example, MSFT shares are trading at an EBITDA EV/NTM of 20.4x (3-year average: 20x). In contrast, Meta Platforms (FB) shares are currently trading at an NTM EBITDA multiple of just 8.7x (3-year average 13.5x). But MSFT’s valuation hasn’t hindered its outperformance versus FB stock over the past three years. The MSFT share recorded a gain of 165.5% over 3 years against 28.2% for FB. Even before FB stock’s momentum collapsed, MSFT stock was still far outperforming it.

Additionally, the stock is also trading in line with its 3-year average as shown above. Therefore, MSFT shares also do not look expensive now based on historical averages. We believe this lends credence to our earlier discussion of its fair value and consensus price targets.

Is MSFT stock a good long-term choice?

We recently discussed Microsoft’s FQ2 earnings in an update. We also touched on its recent acquisition of Activision in a previous article.

Microsoft is the king of SaaS. We’ve often discussed how the company has continued to flex its muscles in the SaaS space. Hence, it has helped the company establish its dominance beyond its leadership in the Office suite.

Moreover, the company also has several levers to take advantage of enterprise software. So, it’s hard to find a flaw in Microsoft’s armor that rivals can exploit. Notably, its consumer footprint was previously mostly limited to Windows and its desktop software. However, the acquisition of ATVI will significantly strengthen its interface with consumers once approved.

Additionally, the company has also recently bolstered its multi-cloud offering for its enterprise customers. We discussed in an Alphabet (GOOGL) (GOOG) article how Alphabet CEO Sundar Pichai and his team are capitalizing on the multi-cloud/hybrid-cloud momentum to grow his share. As the #2 hyperscaler, Microsoft Azure is also keen to embrace the transition to multi-cloud/hybrid in its bid to catch up with AWS.

As a result, Microsoft has now made its cloud security offering available to its multi-cloud customers using GCP and AWS. Additionally, we believe that cybersecurity will continue to play an even more critical role as more workloads migrate to the cloud. Thus, Microsoft has cleverly positioned itself to leverage its leadership in cybersecurity to outperform its hyperscaler rivals.

CEO Satya Nadella also highlighted Microsoft’s increased focus on multi-cloud/hybrid cybersecurity for its customers. He added (edited):

Cybercrime is the #1 threat facing every business today. Our goal is to help organizations implement a complete zero-trust architecture that protects people, devices, apps and data holistically in heterogeneous cloud and client environments. The number of customers using our advanced security solutions accelerated this quarter to more than 715,000. On average, customers save 60% compared to multi-vendor solutions. Our security business revenue exceeded $15 billion in the past 12 months, up nearly 45% year-over-year. (Call on Microsoft’s FQ2’22 results)

The recent cyberwar against Ukraine’s assets also highlights the importance of having top-notch cybersecurity systems. Thus, we believe that MSFT has prioritized its multi-cloud push by leveraging its cloud security solutions. Additionally, it uses a proven playbook to gain market share compared to Google Cloud’s more experimental approach using blockchain targeting industry verticals.

Therefore, we think it’s hard to argue with Nadella & Team’s ingenuity in developing tougher drivers for their business. Microsoft continues to leverage its underlying strength in the SaaS space to gain more share in cloud computing. Given its rapid rise to the #2 position, we believe the company is still very early in its cloud opportunity.

Is the MSFT stock a buy, sell or hold?

If you were waiting for a steep and significant correction in MSFT stock before adding, we think now is the time. Unfortunately, we don’t have clairvoyant powers telling you where the bottom is. However, we believe that MSFT’s strong underlying thesis, coupled with its attractive valuation, are reason enough for you to add more exposure now.

As such, we reiterate our buy rating on MSFT shares.

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