Should You Buy, Sell, Or Hold Microsoft (MSFT)

It’s been a strong start to the year for the mega-cap tech space, and Microsoft (MSFT) has been no exception, up 36% year-to-date, and working on its seventh consecutive quarterly gain in a row. The significant outperformance vs. the S&P-500 has been driven by…

Microsoft’s impressive earnings growth, and consistent double-digit revenue growth rates.

This impressive growth is what’s allowed Microsoft to command one of the highest price to sales ratios among its peers, currently trading at close to 12x. While the stock is beginning to a little expensive here, history would suggest that the stock could get much more expensive if we’re in the latter stages of a long-term bull market where valuations tend to get very frothy.

Therefore, while I wouldn’t be chasing the stock above $216.00, there could be additional upside here medium-term.

Microsoft released its fiscal Q4 2020 results last month and reported a blow-out quarter, with quarterly revenue up 13% year-over-year, driven by continued strength from Azure, and a surprise contribution from Xbox, where sales soared 65% year-over-year.

This massive acceleration in a non-core business and continued dominant positions in cloud computing allowed the company to grow relatively in line with its already robust trailing-twelve-month revenue growth rate of 14%.

Meanwhile, the significant repurchase of $5.1 billion in stock in Q2 alone should help to bolster annual earnings per share growth, as the share count continues to shrink. Let’s take a look at the company’s earnings trend below.

As we can see from the chart below, Microsoft has seen a powerful earnings trend since FY2016, which marked an earnings breakout for the stock. Since that time, annual earnings per share [EPS] has grown rapidly, with a compound annual EPS growth rate of 19.8% over the four years.

Amazingly, this trend in higher highs for annual EPS is not expected to slow, with FY2021 estimates sitting at $6.45, and FY2020 estimates sitting at $7.35. While a minor deceleration from the 21% growth reported in FY2020, these are still incredible growth rates for a company of Microsoft’s size.

Assuming the company meets analyst estimates, annual EPS would grow by approximately 28% over the next two years ($7.35 vs. $5.76). Typically, the best-performing stocks in the market are small to large caps growing annual EPS by a minimum of 17% year-over-year, or mega caps growing at 10% or more consistently.

Therefore, Microsoft fits in the latter category, and until this growth rate slows to a crawl in the single-digit range, there’s no reason to think the stock can’t go higher long-term.

If we look at quarterly revenues, we’re seeing a similar trend, with new highs each year as Microsoft’s products remain a staple, while cloud grows at a rapid pace, with $50 billion in revenue for the segment in FY2020.

Fiscal Q4 revenues hit a new all-time high of $38 billion, and Q1 2021 estimates are sitting at $36.0 billion, which would translate to 9% growth year-over-year. While this is a minor deceleration from the trailing-twelve-month revenue growth rate, which is closer to 14%, I don’t see this as material.

This is because the Q2 2021 estimates forecast 11% growth, so Microsoft should have no trouble maintaining its double-digit growth rate through FY2021. To maintain confidence in the above annual EPS estimates of $6.45 for FY2021, investors will want to…

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