October and November were ugly months for the stock market and, in particular, big-tech stocks. The S&P 500, Dow Jones, and Nasdaq all plunged to 2018 lows, while the FANG stocks, Apple (NASDAQ:AAPL) and Nvidia (NASDAQ:NVDA) all dropped into bear market territory.
But one big-tech giant that remained resilient during the market’s woes in October and November was Microsoft (NASDAQ:MSFT). The company’s strong long-term fundamentals and lack of exposure to near-term headwinds kept Microsoft stock relatively close to its all-time highs in November, while markets were well into correction territory.
The resiliency in Microsoft stock didn’t last forever. In December, as the S&P 500 dropped into bear market territory on rate hike concerns, Microsoft stock finally dropped too. As of this writing, Microsoft stock is now flirting with bear market territory.
But nothing has changed about the fundamentals underlying Microsoft stock. This is still a very healthy company with strong long-term growth drivers, healthy financials and stable, low-volatility fundamentals.
As such, the recent 20% draw-down in Microsoft stock is nothing more than a healthy correction and an opportunity to buy the dip.
Growth Drivers Are Still Strong
One leg of the bull thesis on Microsoft stock is that the company has healthy long-term growth drivers which are unaffected by recent macro-economic noise.
The entire growth narrative at Microsoft is powered by the cloud. Ever since Satya Nadella took over the reigns in 2014, his entire mission has been to pivot Microsoft’s offerings to the cloud. Solutions like Azure, Office 365, and Dynamics 365 were born. For the past five years, those cloud solutions have turned Microsoft from a flattish revenue growth company, to a near 20% revenue growth company.
This growth won’t slow meaningfully anytime soon. The broad concern here is that higher rates will kill business confidence, which will in turn kill cloud-related capital expenditures. This fear is legitimate. But it’s also overstated. Cloud is better than legacy in every way possible, including on the cost front. Thus, even if the economy cools and wages rise, companies will still look to cut costs. One way of doing so is by moving to the cloud.
Considering only 20% of workloads have migrated to the cloud, it looks like there’s still a lot of runway left for Microsoft’s myriad of cloud businesses. As go the cloud businesses, so goes Microsoft stock. Thus, so long as Microsoft’s cloud businesses figure to remain healthy, Microsoft stock will head higher in a medium term window.
Financials Scream Stability
The second leg of the Microsoft stock bull thesis is that the company’s financials are the exact type of financials investors will find attractive during turbulent times.
The balance sheet is rock solid. There’s more cash (~$135 billion) on the balance sheet than debt (~$80 billion). Higher rates won’t add stress to the balance sheet. Nor will they pressure profits much. Last year, interest expense was under $3 billion. Revenues were $110 billion. Even if debt costs rise by more than 30%, to $4 billion, and revenues hit the mark of $125 billion, that would represent just a mere 80-basis-point hit on margins. That’s insignificant in the big picture.
Meanwhile, the company produces tons of cash flow. In each year since Nadella took over, Microsoft has produced essentially $30 billion or more in operating cash flow. That figure is only growing. On a trailing twelve month basis, Microsoft has produced $45 billion in cash flow from operations. Capex rates aren’t that high, so free cash flow is also robust. On a trailing twelve month basis, Microsoft stock has a free cash flow yield of better than 4%.
The aforementioned financials (strong cash positioning, small debt costs and lots of cash flow) are the exact type of stable financials that investors will find attractive amid broader market uncertainty. Thus, so long as markets remain turbulent, Microsoft stock should remain a relative out-performer.
Risks Are Muted
The third and final leg of the Microsoft stock bull thesis is that this company has limited exposure to the broader risks which are weighing on markets.
In the big-tech world, there are five major headwinds behind the recent sell-off: the trade war, higher rates, regulation, valuation and a cryptocurrency bubble pop. Microsoft stock doesn’t have much exposure to any of those headwinds.
This company has largely sidestepped the trade war (tariffs were mentioned only once on the company’s most recent conference call). As mentioned earlier, higher rates won’t depress cloud capex by much. Regulation risks are present only in the very small Bing digital ad part of the business. The valuation is reasonable at 21 times forward earnings for 20% growth. And there is no cryptocurrency exposure.
Overall, the risks killing broader markets are relatively muted in Microsoft stock.
Bottom Line on MSFT Stock
Microsoft stock is a long-term winner undergoing some near-term turbulence. Given healthy growth drivers, strong financials and limited risks, this near-term turbulence is nothing more than a buying opportunity.
As of this writing, Luke Lango was long AAPL, NVDA, and MSFT.