Microsoft: 2021 Top Pick Still Has Room To Grow
Summary
- Despite the recent run, I believe Microsoft stock still has legs, especially once Big Tech weathers the current selling pressures.
- Fundamentally, Microsoft looks very compelling. It runs a diversified, well-balanced business model that has been firing on all cylinders.
- Once the Nasdaq finds its footing, I expect to see MSFT tag along for the ride that may finally take it to the $2 trillion equity valuation.
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Back in November, I chose Microsoft (NASDAQ:MSFT) as my top pick within the FAAMG group for 2021. So far, the company and stock have not disappointed.
Shares have been up 6% year-to-date, even though the mega-cap, tech and growth factors have underperformed the broad market: the Nasdaq (QQQ) was flat for the year, as of the end of February, compared to the Russell 3000's (IWV) 3% gains. Despite the recent run, I believe MSFT still has legs, especially once Big Tech weathers the current selling pressures driven by rising rates and rotation to cyclical stocks.
Credit: Mohammad Rezaie @ Unsplash
Off to the races
The YTD chart below shows how MSFT has outperformed nearly all its direct peers so far in the new year.
Within FAAMG, only Alphabet (GOOG) (GOOGL) stock has topped the performance of the Redmond, Washington-based company's shares in 2021, and by quite a stretch: up 18% in only two months. Other Big Tech names outside FAAMG have been trailing Microsoft as well, including high-fliers Tesla (TSLA), Netflix (NFLX) and Nvidia (NVDA).
In my view, both MSFT and GOOG have been benefiting from one key development that played out through most of last year. Probably not a coincidence, both stocks were the worst-performing Big Tech names in 2020, alongside Facebook (FB) – which I believe to be exposed to more meaningful fundamental risks.
Data by YCharts
The coiled-spring effect seems to have helped to propel MSFT and GOOG higher in the first couple of months of the current year. While some of the upside of investing in either has already been captured, I think that the former still has a long runway ahead.
Room to grow
When it comes to fundamentals, Microsoft looks very compelling.
It helps that the company runs a diversified, very well-balanced business model that is not overly dependent on one single revenue source – one of my main concerns regarding Facebook and, to a smaller extent, Alphabet. The pie chart below illustrates the point by showing the revenue breakdown of Microsoft and two of its Big Tech peers.
Source: DM Martins Research, data from multiple sources
But also, Microsoft has been firing on all cylinders. As I argued after the most recent earnings day, there has been no meaningful weakness in the company's financial results as of late:
- Business and productivity have been benefiting from the multi-decade digital transformation – think Office and LinkedIn, and how both have been at the center of how business is conducted. Things only got better with the more recent transition to the cloud and last year's work-from-home trends.
- More personal computer pulled off a Benjamin Button and is no longer a mature segment, now that demand for tech devices has increased substantially on the back of the COVID-19 "new normal". It does not hurt that home gaming is in the early stages of the new console cycle, which is a positive for Xbox at least in 2021.
- Intelligent cloud is where Microsoft's crown jewel, Azure, lives. The business continues to see strong double-digit growth, in a bullish cycle that is likely to last a multi-year period – including on the back of greenfield and brownfield opportunities to expand the addressable market.
Market dynamics will eventually improve
Despite the strong fundamentals, I do not believe that Microsoft's 2021 performance, even if strong, will catch many investors by surprise. The company has set the bar high (EPS is projected to grow a whopping 30% in the current fiscal year, on top of an already impressive 2020), and only mic-drop financial results will be good enough to spark a "bull attack".
But I believe the next leg up in Microsoft shares will come from improved market dynamics. Cyclical, high-beta and small-cap stocks have been dominating market action in 2021, as investors expect a strong post-pandemic rebound in economic activity. For now, Big Tech has taken a back seat.
Once the dust settles and interest rates find some stability, I believe well-run, industry-leading companies in the tech sector will see their stocks get rewarded again with improved investor sentiment. Once the Nasdaq finds its footing, I expect to see MSFT tag along for the ride that may finally take it to the $2 trillion equity valuation.
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This article was written by
Daniel Martins is a Napa, California-based analyst and founder of independent research firm DM Martins Research. The firm's work is centered around building more efficient, easily replicable portfolios that are properly risk-balanced for growth with less downside risk.
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Daniel is the founder and portfolio manager at DM Martins Capital Management LLC. He is a former equity research professional at FBR Capital Markets and Telsey Advisory in New York City and finance analyst at macro hedge fund Bridgewater Associates, where he developed most of his investment management skills earlier in his career. Daniel is also an equity research instructor for Wall Street Prep.
He holds an MBA in Financial Instruments and Markets from New York University's Stern School of Business.
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On Seeking Alpha, DM Martins Research partners with EPB Macro Research, and has collaborated with Risk Research, Inc.
DM Martins Research also manages a small team of writers and editors who publish content on several TheStreet.com channels, including Apple Maven (thestreet.com/apple) and Wall Street Memes (thestreet.com/memestocks).
Analyst’s Disclosure: I am/we are long MSFT, AAPL. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (12)
$AAPL ($2.2 Trillion market capitalization) having reached that benchmark $2 in August, is likely to be first joined by $MSFT to form a prestigious "$2 Trillion Club", as it needs only to grow by 12.5% to attain that coveted benchmark. Lagging in the hunt are Amazon (needs 26.5% growth) and Alphabet/Google (needs 43.4% growth). There are presently no other US companies in the hunt, nor European, Japanese, Korean, or Chinese companies.IMO, Satya Nadella (appointed CEO in 2014) is the 21st century epitome of the positive impact a new CEO might bring to a mediocre giant suffering under mediocre management (e.g., Steve Balmer).Of course, at this point, what matters most to Apple, and soon Microsoft, is the ability to put $2 Trillion in the rear-view mirror, and strive for $3 Trillion. IMO, both companies have the talent and management to advance another 50+% within 3 to 6 years--depending upon the strength of world economies, and timing of the next worldwide (or nearly so) period of economic distress/recession--China being a wildcard. (The 'rule of large numbers' notwithstanding.)Apple is the more consumer oriented; Microsoft the more enterprise oriented.In the Info Tech Sector, I'm long APPL, AVGO, CSCO, INTC, MA & MSFT, as well as these funds: BST, QQQ, WCLD & XLKRich-untrack:12hrs
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BTW, Carter Worth (dubbed 'Chartmaster' by CNBC), recently made a convincing case on Fast Money that Mr. Market does not make significant advances without the Tech stocks leading the way. (Regrettably, I can't locate a link to offer)
