Microsoft Stock: I’m A Buyer If This Happens (NASDAQ:MSFT)

1. Introduction

We are in the midst of a bear market and like the entire tech sector, Microsoft (NASDAQ:MSFT) has suffered considerable share price losses. The stock lost around 35% from its all-time high of $349.67 on November 22, 2021.

On the one hand, MSFT has underperformed the major indices, such as the S&P 500, Dow Jones as well as the Nasdaq (see chart).

On the other hand, however, MSFT is an outperformer among the so-called FAANG stocks together with Apple (NASDAQ:AAPL).

So, should investors rush into MSFT now?

2. Fair Value

I prepared two valuation models in order to make a more accurate assessment of the valuation. I have chosen a conservative approach due to the monetary tightening phase of central banks on a global scale and the related rapidly rising interest rate environment. Other factors favoring a conservative approach include the uncertain macroeconomic and political environment and rising recession risks, which have probably not yet been fully priced in.

The first valuation method is based on a DCF calculation. In order to choose a conservative approach, I have chosen a growth rate of 10% per year and a growth decline rate of 1% in terms of the free cash flow. Analysts’ consensus predict FCF increase of around 18% in FY 2024 and FY 2025, according to the current indications on MarketScreener. However, I find these predictions too optimistic considering the current market environment and assume that a potential recession is not yet priced in.

In terms of Price/Cash flow multiple, I have chosen a multiple of 14.60 for the last FCF, which represents the current average multiple of the S&P 500. This Price/Cash flow multiple is below MSFT’s current multiple of 19.26 and well below its 5-year-average of 23.10, according to Morningstar.

In the first valuation method based on a DCF calculation, the fair value is $179.49, which corresponds to a current overvaluation of the stock of 22% (see figure below).

The second valuation method is based on an earnings-per-share calculation. In order to choose a conservative approach, I have chosen a growth rate of 8% per year in terms of EPS growth. The 5-year average EPS growth rate was 29%, according to the latest indications on Morningstar. Analysts’ consensus predict EPS growth of around 18% in FY 2024 and FY 2025, according to MarketScreener. However, I find these predictions also too optimistic since they probably do not include the impact of a potential recession.

In the second valuation method the fair value is $183.37, which corresponds to an overvaluation of the stock of 20% (see figure below).

3. Technical Analysis

From a technical point of view, it is noticeable that MSFT is still stuck in a downtrend, which favors a further decline in the share price (see following chart).

While several attempts to break above the resistance failed, $188 could serve as a short-term support to the downside.

Eventually, the area between $188 (Pre-COVID-high) and $134 (COVID-low) could serve as a potential buy zone for investors.

4. Conclusion

Microsoft is a great company with great fundamentals and financials. The cash hoard of $107 billion as well as the healthy cash flow and profits give the company strength and flexibility to weather a potential economic storm and rising interest rate environment.

The potential Activision Blizzard takeover (NASDAQ:ATVI) as well as MSFT’s investment in ChatGPT prove management’s vision and ensure that the company continues to be positioned well for the future.

However, my fair value calculation based on a DCF method shows an overvaluation of the stock of 22% and my fair value calculation based on an EPS method indicates an overvaluation of around 20%.

Additionally, the technical analysis indicates a further downtrend to the area between $134-$188, which would serve as my potential buy zone.

Since the major indices Dow Jones, S&P 500 and Nasdaq are also caught in their downtrends, the Fed’s monetary tightening seems to continue and the macroeconomic situation could lead to a recession, there is no rush to buy MSFT from a current fundamental and technical point of view.

Finally, as soon as the tide turns, MSFT is one of the first stocks I intend to add to my portfolio and, in my opinion, one of the greatest companies and business to own.