Microsoft Stock Market Forecast: What to Watch for in 2022 (NASDAQ:MSFT)

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Thesis article

Microsoft Corporation (NASDAQ: MSFT) is one of the most dominant technology companies in the world, and as part of the GAMMA Group, it performed very well in 2021. This was partly driven by underlying business growth, but multiple expansion also played a role. Microsoft is trading at a relatively high valuation – given its quality and strong growth opportunities, a premium valuation seems warranted, but with interest rate hikes looming, MSFT could still experience multiple contraction headwinds in the future. course of the next few years.

Microsoft Assessment

Microsoft Corporation is a leading technology company with a huge gap in its core businesses and with exciting growth opportunities in areas such as cloud computing and the emerging metaverse. On top of that, Microsoft has excellent fundamentals, which include huge returns on capital, high margins and a strong balance sheet – one of only two in the world rated AAA. So it’s not too surprising to see Microsoft trading at an above-average valuation, but MSFT is also currently trading at a considerable premium to how the company’s shares have been valued in the past.

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Data by YCharts

At current prices of around $335, Microsoft Corporation is valued at just over 36 times forward earnings, which equates to an earnings yield of just under 3%. This represents a premium of around 15% to the median 5-year earnings multiple, and a fairly large 33% premium to the median 10-year earnings multiple.

To some extent, it’s safe to say that Microsoft’s rise in earnings multiple over the past decade was justified, as the company has successfully transformed itself into a cloud- and mobile-centric company – something that doesn’t. wasn’t guaranteed ten years ago. However, when a company’s stock is priced at a significant premium to the longer-term average, investors should consider the downside risk associated with the potential for multiple compression.

Considering Microsoft’s valuation based on enterprise value to EBITDA, which accounts for changes in debt usage over time, MSFT also looks expensive:

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Data by YCharts

At 25x forward EBITDA, Microsoft Corporation is trading at a relatively high valuation in absolute terms, and also at a fairly large premium of around 100% to the median 10-year EBITDA multiple of 12.7. Microsoft’s net cash position, as a percentage of its market capitalization, has declined over the past two years, leading to growth in the value of the business (where net cash is subtracted), which explains a part of the EV/EBITDA multiple expansion seen in the recent past. Yet Microsoft has clearly seen its valuation rise significantly over the past two years. For those who bought MSFT early on, it was great as they saw their stocks rise on multiple tailwinds for expansion. For someone considering investing new money today, the multiple expansion we’ve seen over the past two years isn’t great, however, because investing new money in stocks at historically high valuations could result in below-average returns due to multiple compression headwinds, when the valuation normalizes towards the historical range.

Should Microsoft stock rise?

Over the long term, I think Microsoft will almost certainly see some gains in its stock price. The company will generate business growth for many years, which should lead to increased earnings, and as MSFT regularly buys back shares, these earnings are spread over a decreasing number of shares, resulting in further growth in earnings per share. . As EPS rises, perhaps for decades, MSFT shares will also rise in the long term – but not at the rate seen over the past two years. In the short term, stock price gains are less certain – earnings per share will most likely be higher next year versus the current year, but due to the high valuation of MSFT transactions at the moment, earnings per share could be offset by a multiple contraction. This multiple contraction is not a certainty, of course, but could occur if interest rates rise faster/earlier than expected, or if the broader market experiences a correction, etc.

What is the Microsoft Stock forecast for 2022?

Let’s first see what Wall Street thinks of this question:

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Data by YCharts

As can be seen in the chart above, analysts believe that Microsoft will see attractive share price gains in 2022. The current consensus price target stands at $371, implying an upside around 10% from the current level over the next twelve months, as is the usual timeframe for Wall Street price targets. Price gains of 10%, with a dividend yield of 0.7% on top, would be a pretty attractive return, although that pales in comparison to the returns MSFT has generated over the past two years – shares have risen by 51% in the last twelve months and has increased by 430% in the last five years. It is, I believe, almost certain that returns like this will not be possible in the future – the law of large numbers states that adding 10%, 20% or more per year to a company’s market capitalization becomes more and more difficult as a company grows in size. Quintupling MSFT’s market capitalization from $500 billion to $2.5 trillion over the past five years was already a feat, but quintupling it again – which would require adding 10 trillion dollars market capitalization – seems extremely unlikely, at least for the foreseeable future.

If the analysts are correct, then MSFT will deliver very strong returns in 2022, but these will not be comparable to what we have seen in previous years. For those who believe that MSFT will continue to worsen at the rate seen in the recent past, 2022 could therefore be a major disappointment. Analysts tend to be somewhat optimistic about their price targets, so it’s also possible that MSFT offers lower total returns than what analysts are predicting. Current estimates are that MSFT will earn $10.50 over the next fiscal year (which ends in June 2023 and begins in July 2022) – if MSFT were to trade at 33 times that number in a year, which still wouldn’t be a low valuation at all, its shares would trade essentially in line with where they trade today.

I am therefore more conservative than the analyst consensus and believe that MSFT could generate sub-double-digit returns in 2022. Depending on general market conditions, even a decline in the share price is possible – not because MSFT is a bad company, but due to this it is a great company trading at a valuation well above historical levels.

Is the MSFT stock a buy, sell or hold?

Microsoft is one of the best investments in the world, I believe, when we take the valuation off for a second. The company has an excellent moat through its MS Office cash cows and operating system business, and is a leader in the fast-growing cloud computing business with its Azure division. Microsoft also has strong leadership, excellent fundamentals, and the company is one of only two companies in the world with a AAA rating. Strong cash flow allows Microsoft to return billions of dollars each year to company owners through buyouts and dividends. Finally, Microsoft is benefiting from strong industry tailwinds as the world becomes increasingly interconnected and digitalized, providing strong tailwinds for growth across Microsoft’s many different business units, including cloud computing. , Office and even in areas such as games.

Microsoft’s valuation is quite high, however, and that shouldn’t be overlooked. Over the long term, earnings growth will likely result in a sharp rise in the stock price, but that doesn’t mean stocks will necessarily be trading higher within a month or a year. In 2022 we will likely see several Fed rate hikes, and these could put pressure on expensive growth stocks such as Microsoft – with much of any future earnings in the future they will feel an impact. more pronounced of a rising discount rate relative to value stocks where a higher share of all future earnings will be generated in the short term. However, the potential headwinds of higher rates will not necessarily drive the stock price lower. Sentiment and psychology also play a huge role, and a growing focus on the metaverse could help MSFT’s share price. Microsoft is seen as one of the most likely winners of the future Metaverse by many investors, especially in the “work Metaverse”, where MSFT seeks to succeed on both the software and hardware side – with products such as HoloLens 2. If this narrative holds, and if hype around the Metaverse remains high or continues to grow, Microsoft could see its stock perform well despite an above-average valuation.

Overall, there are both opportunities and threats to MSFT’s stock in 2022. The company will do well operationally, as it has for many years. According to the analyst community, equities will offer total returns of around 10% next year. I’m a little more conservative and think there’s a good chance that returns will be in the single digits due to multiple contraction headwinds. For someone interested in owning MSFT for many years – and the company appears to be an excellent choice for such an investment – performance in 2022 won’t matter too much, however, and MSFT is well positioned to perform well on a operational base for many years. , with exposure to many growing markets such as cloud computing, gaming and Metaverse (I see MSFT as a much better Metaverse game than NVIDIA (NVDA), trading at almost 70x net earnings).

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