Microsoft Stock: Is it Time to Buy Yet?

Microsoft is a wonderful business. The tech stock has corrected, and long-term investors should seize the opportunity to buy on weakness.

| More on:

Despite the scary tumble of 32% from its 52-week and all-time high, Microsoft (NASDAQ:MSFT) stock still has a wonderful underlying business. The main culprit of the selloff in the quality tech stock is the valuation compression of stocks in general due to quantitative tightening.

Money supply rose during the pandemic period. For example, there were government programs to help workers and businesses that were directly impacted by economic shutdowns related to the pandemic.

As well, high inflation is devaluing fiat currencies, including U.S. dollars, more quickly than normal. Rising interest rates make it more costly for businesses and consumers to borrow. Consequently, businesses’ growth projects look less compelling now than they did a year ago. Businesses are expected to invest less, and consumers are expected to spend less. Ultimately, it leads to a reduction in businesses’ earnings outlook.

As it looks like the new normal in the near term will be high inflation and rising interest rates, stocks, including Microsoft, will continue to be pressured over the next while.

Valuation and returns

Other than choosing a great business, the valuation investors buy stocks at also affect their investment returns. From its peak, MSFT stock simply retreated to a more normalized price-to-earnings ratio (P/E).

Despite the recent bear market, in the last decade, MSFT stock has still delivered annualized returns of approximately 25.7%. In other words, it grew an initial $10,000 investment into $98,770! Compared to the returns of 12% per year from the U.S. stock market (using SPDR S&P 500 ETF Trust as a proxy) that transformed the same initial investment to $31,090.

Much of the tech giant’s decade’s growth came from the transition to cloud, led by Satya Nadella, who took over the role of Microsoft’s chief executive officer since February 2014.

Over the next three to five years, 49 analysts have an average earnings-per-share (EPS) growth rate estimate of 15.4% for MSFT stock. Assuming a more normalized target P/E of about 22.3, the quality tech stock can deliver annualized returns of about 13-14% in the period.

Microsoft stock is a decent buy at current levels, but the market correction can continue for some time. If you want to buy closer to a P/E of 22.3 for a safer entry point, wait until a drop to the $205-per-share level.

Microsoft is still a wonderful business

Using fiscal 2019 as a base year for comparison, Microsoft improved its gross profit margin to 68.4% from 65.9%. Its three-year revenue-growth rate is 16.4%, which is superb for a large-cap company that has a current market cap of over $1.7 trillion. Its operating income of over US$83 billion is almost double the levels from fiscal 2019. Its operating margin improved to 42.1% from 34.1%, which indicates management has been controlling costs really well.

Microsoft is also a free cash flow (FCF) machine. It brings in annual FCF of over US$65 billion. Its fiscal 2022 payout ratio was 28% of FCF and 25% of earnings. With the double-digit EPS growth expectation and a safe payout ratio, investors can expect many more years of dividend growth. For reference, its five-year dividend-growth rate is 9.6%, which aligns with its most recent dividend hike of 9.7% in September. The company also allocates about 27% of its operating cash flow in capital investments for long-term growth.

It only yields about 1.15% right now. So, investors of MSFT are seeking growth. In this environment, it’d be prudent to space out one’s purchases. If you like the company, consider taking a partial position and adding more shares on further weakness.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng has a position in Microsoft. The Motley Fool recommends Microsoft. The Motley Fool has a disclosure policy.

More on Tech Stocks

cloud computing
Tech Stocks

3 No-Brainer Tech Stocks to Buy With $1,000 Right Now

These three Canadian tech stocks could be among the best growth opportunities in the market right now.

Read more »

happy woman throws cash
Tech Stocks

3 Growth Stocks That Could Be Long-Term Wealth Creators

These three growth stocks aim to grow their financials at a higher rate than the industry average, thus delivering superior…

Read more »

The virtual button with the letters AI in a circle hovering above a keyboard, about to be clicked by a cursor.
Tech Stocks

Is POET Technologies a Top AI Stock for Canadian Investors?

Canada has relatively few AI stocks, and the ones it has are different from American AI stocks in terms of…

Read more »

Rocket lift off through the clouds
Tech Stocks

2 Growth Stocks That Could Skyrocket in 2025 and Beyond

Wondering what types of stocks could rapidly rise in 2025? Check out these two stocks with substantial upside if they…

Read more »

up arrow on wooden blocks
Tech Stocks

The 3 Smartest Tech Stocks to Buy With $500 Right Now

Tech stocks can be seen as a bit risky, but these three have far less risk and more stability for…

Read more »

TFSA (Tax-Free Savings Account) on wooden blocks and Canadian one hundred dollar bills.
Tech Stocks

Shopify: A Must-Have Growth Stock for Your TFSA Now (and the Next 10 Years)

Shopify (TSX:SHOP) stock isn't just a top growth company, it's a titan worth owning in your decades-long TFSA fund.

Read more »

cloud computing
Tech Stocks

Best Stock to Buy Right Now: Manulife vs CIBC

Want the best stocks? These two are certainly the best options. But which is the better buy?

Read more »

profit rises over time
Tech Stocks

4 Reasons to Buy Constellation Software Stock Like There’s No Tomorrow

Constellation Software stock continued its climb upwards after recent earnings, and this only adds to its appeal.

Read more »