The stock market is best associated with a pendulum. It's rarely balanced, but inevitably comes back to the balanced state from time to time. That's why it's critically important to know what a company's balanced (or rational) price is at the moment in order to understand what to expect.
1. Technical parameters
From the way the stock price of a company reacts to sharp market movements, one can judge its fundamental state. Over the past month, which coincided with a noticeable rise of the US stock market, Microsoft (MSFT) has grown in price less than its closest competitors have. This is a bearish sign.
Starting 2012, Microsoft stock price has been following its long-term exponential trend that acts as a smart average:
The actual price of the stock is currently deviating from this trend almost by 20%. It means that Microsoft stock price has been growing much faster than exponential rate. Generally speaking, this is not normal at all:
The annual price return of Microsoft has been mostly above the average since 2017. It is also too optimistic to go on.
So, technically, Microsoft’s stock price looks unstable now and not ready for further strong growth.
2. Growth drivers
In case of Microsoft, there are several qualitative dependencies which allow us to judge how balanced the company's price is. I will focus only on the strongest of them.
Let's start with revenue. Over the last 10 years, Microsoft’s capitalization has been in a strong linear relationship with its revenue TTM absolute size:
Within this model, the company's current capitalization exceeds its balanced value by more than 11%.
Having considered the short-term relationship between Microsoft’s revenue growth rate and its EV/Revenue multiple, it should also be recognized that the current ratio of the multiple is in the “expensive” zone:
The similar long-term relationship indicates the same thing:
Considering the long-term relationship between EBITDA's absolute size and the company's capitalization, Microsoft's current price is slightly overvalued too:
Over the last six years, Microsoft's capitalization has been responding well to the FCF growth rate. As demonstrated by the following chart, the current growth rate of this indicator does not justify the company's current price:
So, in the context of well-established relationships, Microsoft's current price is classified as clearly overvalued.
3. Comparable valuation
In this section, I would like to offer a comparable valuation of Microsoft through multiples. But first, I want to note that at my glance a direct comparison of multiples does not give a correct result, because companies are always in different phases of their life cycles. Therefore, when comparing multiples, we should adjust them to the growth rate.
The comparable valuation based on the EV/Revenue to growth multiple has shown that Microsoft is one of the most expensive companies in the market:
Comparing Microsoft through the EV/FCF to growth multiple, we get almost the same result:
The comparable valuation based on the EV/EBITDA to growth multiple is more interesting. In this case, the implied price is slightly above the actual price:
Now, let's look into the future. We will do the similar comparable valuation using the P/E (forward) and P/S (forward) multiples adjusted by the expected annual growth rates of earnings and revenue.
This is what we get analyzing the P/S to growth (forward) multiple:
But history teaches that it is absolutely normal for the market to evaluate the company like this:
And, finally, judging by the P/E to growth (forward) multiple, Microsoft is overvalued by 20%:
I think that the market is more inclined to evaluate companies that pay dividends through multiples based on earnings parameters. And therefore, I am more inclined to believe that Microsoft is definitely not cheaper than the main blue chips in Nasdaq.
4. Risk Parameters
Currently, Microsoft's Bearish Beta (a measure of how a stock price tends to drop when the market is only down) is bigger than the Bullish Beta (a measure of how a stock price tends to rise when the market is only on the rise). It means that Microsoft stock is more responsive to the overall decline of the stock market than to its growth.
I want to pay attention to four points:
- Microsoft stock price has been growing at a faster than exponential rate for a long time. As a rule, it indicates an unstable state.
- Microsoft’s accelerated revenue growth phase is over, which means that the company will not be able to maintain the current value of the P/S multiple in the near future.
- The company is rather overrated in comparison with the main blue chips in Nasdaq.
- Microsoft stock is more responsive to the overall decline of the stock market than to its growth.
So, I think that Microsoft's rational capitalization is below the current level.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I don't have a trade position regarding Microsoft. And I believe that to be an advantage in terms of analysis because I am able to consider indicators impartially without subliminal motivation to see positive or negative sides even if they don't exist.