Microsoft posted impressive earnings last week. MSFT stock initially shot upward. Then, all gains were erased and MSFT stock then fell back downward. If Microsoft is improving their revenues & profits, why would the stock not continued to move upward? There are two main reasons for this, the first is that it is not enough and the second is overall market sentiment is pulling all stocks downward. These are the elements that I wanted to focus on.
First, while Microsoft is adding additional revenue and earnings, the overall picture is less impressive when you compare Microsoft’s potential yield versus alternatives. And, this is affecting all stocks, which goes toward the sentiment. As interest rates continue to move higher and higher, alternatives are more attractive investments. This is affecting stocks across the board.
Breaking down the individual aspects of Microsoft’s latest incomes statement show that there were improvements across the board – starting with revenue increases. Microsoft pushed revenue from $56.19B to $56.52B, an addition of $330M for the quarter. This beat consensus expectations.
I had to increase revenue for 2024 because the revenue increase from above was more than expected. And, I also had to increase 2025 revenue projections that analysts are expecting. In all, Microsoft is adding more and more revenue. Continuously increasing revenue is one of the principles sought for with value investing. A value investors would want to see revenue increasing every quarter to add more potential profit to the investment.
Net margins are strong and have printed the highest level since 2022. The increasing revenue gave Microsoft more room to improve margins through economies of scale. However, increasing revenues are not likely to continuously increase net margins overall ad infinitum. Microsoft will expand its costs as they will have more revenue and earnings to work with. Still, the increase is very impressive.
Earnings Per Share
This is where a lot of my focus gravitates toward is future earnings. 2024 saw a revision higher in earnings. Microsoft will earn $11.23 for the year. But, is it enough to satisfy Mr. Market’s appetite for yield? At the current price level, $334.51, with $11.23 in future earnings for the year, this puts yield at 3.357%.
When interest rates were down below 2.500%, a yield such as 3.357% was solid as it had a premium for risk built in to it. But, the benchmark 10-year US Treasury yields are now printing ~5.000% and as an alternative, Microsoft’s yield is too low at this price point. While Microsoft is undoubtedly going to continually print positive, increasing revenue, the alternatives come with little risk. Those investors who are seeking yield are going to sell their MSFT stock en masse and gravitate toward a more secure, lower risk alternative that the US 10-year Treasury note will offer. This will continually pressure MSFT stock lower as fewer and fewer are chasing a lower yield.
At some point, however, MSFT price will be offered at a level that would push investors toward this as an alternative to the benchmark rate. This would be a price point where yield exceeded the US 10-year Treasury yield and had a built in risk premium. If MSFT were to trade at a yield level of perhaps 5.750% – $195.00, investors would step back in.
During the time that MSFT trades at such a higher price-to-earnings level, I expect we will see this chart diminish more and more as stocks broadly adjust to an environment where interest rates remain higher for longer. And, if future economic indicators continue to pressure the Fed to potentially push interest rates even higher, the price-to-earnings ratio is likely to move much lower to the 20x level.
Microsoft MSFT Stock
As a value investment, I like Microsoft a lot. It is a bastion within the economy. They will continue to print higher and higher revenues, and by extension, profits. But, the alternatives are too juicy by comparison. This is occurring in a new investing landscape. Most stocks within the tech sector are being pressured. This falls in line with basic principles of value investing that you first start with the benchmark and then compare. Given that, I see continued pressure on the tech sector as the US 10-Year Treasury is sitting at ~5.000%. An investor would have very little risk of investing in the benchmark rate versus an investment in MSFT.
The investing landscape is shifting and many investors are fighting the environment. But, if interest rates continue at such high levels, this will undoubtedly push MSFT price lower and stay there, not to mention the effects on the broader economy. If higher interest rates have the intended effect of crimping inflation, this will have been achieved by a contracting economy. That would mean that Microsoft may not hit its goals for 2024, which means that MSFT has more downside risk than upside reward.
I like Microsoft as a company. I do not like MSFT stock at this price.