Microsoft Stock in Trouble? (-25%) MSFT Stock Analysis

Hi, I'm Jimmy. In this video, we're looking at Microsoft, ticker symbol MSFT. So, [snorts] in this video, we're going to look at the basics of Microsoft's business. We're going to run through some recent events. The stock is down a decent amount. Uh, we're going to look at some of the key numbers. Then, we're going to try to come up with a fair value for Microsoft stock. Now, just so we're on the same page, I'm going to do this entire analysis on the Investors Grow website where we try to make it quick and easy to help people analyze companies. This is their homepage. But for now, let's jump in and look at their individual segments. Now, as you can see, Microsoft is in a lot of different businesses. I mean, they have everything from their gaming division. They bought Activision that's in there with Xbox, Xbox Live, all of that stuff. They own LinkedIn. That business has been doing decent. Sometimes it's interesting to jump in and look at some of those individual numbers. But their big businesses is their subscription services and more recently their cloud services. Now, we jump over and look at a chart for Microsoft stock. Well, this is a one-year chart. And what's interesting about this is, as you can see, they're about flat over the past year. Think about a company as good and as big as Microsoft is. I mean, we'll look at some of their numbers in a minute, but they're a beast. And the stock's about flat. Now, what's interesting here is that if we go back to the end of October, well, they reported earnings. That's this peak up here. Well, since then this stock is down by about 25%. Now, right around that peak when earnings were report well the uh Microsoft came out and announced that they were restructuring the deal with Open AI and they were getting about 27% ownership in Open AI. So, in theory that's a good thing. Stock kind of bounced jumping it jumped up leading into earnings. Then earnings came out and interestingly they reported 378 per share I believe it was for that quarter and the stock and that was about 12% higher than estimates at the time. So they beat estimates then the stock pulled back and as we could see it's kind of continued to pull back. Now that was the end of October. At the end of January they went ahead and they reported again and they actually beat estimates by about 5% there. they reported us like $4 and3 cents a share or something like that and they beat estimates slightly but again the stock continued to pull back. Now this leads us to into some of the reasons why this stock is down as much as it is. Now if we think about if what we know about Microsoft is they have a big relationship with open AI. They have a ton of different lines of businesses. We saw that in the pie chart before. But they are spending obscene amounts of money towards the development of artificial intelligence. Now just to illustrate this a bit, let's jump over and look at a chart of capital expenditures including analyst estimates for capital expenditures. And we can see here that the blue bars are historical numbers. The green bars are analyst estimates. I just want us to compare so we can see how that looks on this chart. It doesn't look that large compared to where analysts are expecting it to go and this is not some random guess that analysts are making. Management has come out and stated how much they plan on spending. Now analysts do have after projections of it rising up. I just want to point out kind of tails off at the tail end there. We'll come back to this in a little bit when we look at uh free cash flow. But one of the big problems with this company, stock is exactly what we see happening here. Ultimately, the concern is, is this going to lead to return on investment? Are they is that money going to get returned to them? And there's been questions recently about whether or not it will. Obviously, we can see that in their stock price. Now, one of the big takeaways for me when I was reading through their most recent quarterly report and I was watching or listening to the analyst call and stuff like that, this most recent pullback here on the stock. By the way, I own a piece of Microsoft and so this is a stock. This is a company I like. I've liked Microsoft for a long time, but I am trying to keep up with it. That's the reason I wanted to make this video today because one of the things that jumped out at me, they reported remaining performance obligations, RPO for short, of about $625 billion. That's a jump of more than double. It was like 110% increase. And remaining performance obligation is essentially backlog customers that have signed up and they plan on receiving services down the line. Essentially, they have signed contracts with Microsoft, but Microsoft hasn't collected that money yet. 625 is generally a good number. This is an important number to look at when we're looking at any type of software type of company or company that's offering this type of service where there's kind of I don't want to say a guaranteed like revenue stream, but these are contracts in place and as long as those companies don't go out of business, they can expect that revenue. But here's the big twist to the whole

thing. of that 625 billion in RPO, well 45% of that is coming from Open AI. So Chat GPT is essentially signed up for 45% of the $625 billion that Microsoft is supposed to bring in. That's about $280 billion. Now obviously Open AI is not a public company, at least not as of yet. But I keep seeing them they're going out to raise a hundred billion here. 50 billion here. They're raising a ton of money. So, it is a little bit nerve-wracking as an investor in Microsoft. to have that type of concentration risk where 280 billion is coming from a single customer. A single customer that appears not to be profitable and keeps having to go out and raise money. This, to me, this is a big deal. And I kind of get how the market didn't react all that well to it. On top of that, Microsoft also in the in last quarter when they reported at the end of January, in that last quarter, they saw it was like a 66% jump in their capital expenditures in the money that they spent on capital expenditures. And they stated that a lot of that money that they're spending, the thing is that if you're going to spend all that money on capital expenditures, you're doing it to buy more servers to expand uh Azure's, you know, platform, their processing capabilities. They're spending all of this money to essentially service that 625 billion in obligations they have coming down the line. There's just a lot of moving parts to this. And I think that the market understandably reacted with some hesitation. The real question is, is this an opportunity? I still think Microsoft's a fantastic company to get a better look at that. When we jump in and look at some of the other numbers, this is a chart of revenue and clearly revenue has grown fairly well over the past few years. Although again, a lot of times it's better to look at revenue growth. And yes, in the most recent trailing 12-month period, it has pulled back a little bit. But broadly speaking, they've actually done, considering how large they are, they've actually done a very impressive job of growing. And this pullback, although it is mildly concerning early stages of it, and I'm again not surprised that the market reacted like that, I'm not expecting this thing to go negative anytime soon. I'd be surprised if it goes up and maintains double-digit growth numbers. But if it stays high, singledigit growth numbers, I personally would be fairly happy with that. And when we jump over and look at profit, well, this is a chart of net income. And again, net income has grown fairly well. And when we look at net income profit margins, interestingly, profit margins have actually done fantastically well on top of net income growing, profit margins have actually grown, too. So again, this is a solid sign. Now, a lot of the business uh around, you know, the deals that they're doing with Open AI, they tend to have decent margins compared to other businesses, like for example, their gaming business. the margins are smaller over there. So, the fact that they're seeing so much growth in their higher margin businesses or at least some of that explains it why this chart is slightly rising. But again, looking at their profit, looking at their profit margins, this looks fairly good. Now, before we jump over to the fair value, look at a few more of the numbers, I just want to point out one of the things that makes Microsoft as strong as they are. This is a chart of cash, short-term investments, and long-term investments. And clearly, they have a ton of cash. I mean, their cash is they have more cash right now than a lot of companies are worth. So, I just I only brought this up because, you know, I'll see they're going to spend, you know, $80 billion on, you know, capital expenditures or opening up a new data center or something like that. And yes, that is a big number. And then I start like going down the rabbit hole of what are they where are they going to get the money and all that stuff. And you realize, well, they have a lot of money and they generate a ton of free cash flow. So with that being said, when we jump over and look at free cash flow, well, we can see last year they put up about $77 billion in free cash flow. And [snorts] clearly that's quite good. So free cash flow is operating cash flow minus capital expenditures gives you free cash flow. There's actually other perhaps better ways to calculate it, but roughly speaking that's about the formula. There are other formulas to get to similar numbers, but in this case, we're just using the simple formula of operating cash flow minus capital expenditures gives you free cash flow. We can see with this calculation here, well, they put up about $77 billion and free cash flow has grown fairly well. we can see the longerterm trend has gone up and

that is despite their increase in capital expend yeah expenditures that we've already seen they've still been able to kind of outgrow their spending but we'll see how that translates when we jump over and look at the fair value so first let's jump in and look at the historical forward price to earnings multiple from the investors grow website on so this is the past 10 years and basically at the end of each quarter kind of maps out what's the forward PE at that point in time and you end up with the chart. The idea here is that you want to buy it when it's on the lower end. You want to get an idea of the overall trend. Impressively, their overall trend has been fairly steady and we can see that right now it's down near its 20-year average. So, in recent years, it's been a bit higher. The averages have gone up a bit little bit, but it is on the lower end right now. So from a fair value perspective, 23x from on a forward PE basis isn't all that bad. So perhaps this stock does look like it's undervalued right now. Again, I often times like to double check. The reason why you have, you know, it's like nine or 10 different valuation methods on the investors grow website. The reason we have so many is that when you're analyzing a company, a lot of times it's good to doublech checkck the valuation method with perhaps another complimentary valuation method. In this case, we've got discount of free cash flow. So, First, we look at this chart here. Green bars historicals, green bars, estimates, blue bars, historicals. Well, we can see that free cash flow is expected to ramp up. Analysts have it ramping up. They kind of have it pulling back in 2026 and then continuing up. Now, we see a big jump in free cash flow in the final year of estimates here. And if we think back to the chart that we had on uh cash capex on capital expenditures, think back to that chart. Remember when the chart was going up and they kind of leveled off, even dropped down a little bit. Well, if they stop spending as much money as they are, let's say pretend from one year to the next, they just repeat their capital expenditures, but operating cash flow continues to grow. Well, you end up with a big jump in free cash flow. And that big jump in free cash flow is giving us a fair value of somewhere near $260 per share. And according to this kind of free cash flow, this stock still looks fairly overvalued. Now, what's interesting about this is we end up with two contradicting points. priced to earnings that says it could be on the lower end, could be undervalued, could be an opportunity. Then you end up with discounted cash flow. Looks like it's a bit on the higher end, perhaps waiting for a bigger pullback. Now, for me, I already own this stock and I am by my nature a long-term investor. So, I'm more than happy to wait this out for the next few years, see how this all plays out. Microsoft continues to be one of the top companies in the game. Now, if I were buying this stock, if I wanted to buy more of it today, I'd be waiting for a bigger pullback. This one's already a decent sized position in my portfolio. So despite the stock pullback, I wouldn't be adding more here, but it is a company that I still like. I am very much going to keep my eye on the concentration risk around open AAI, especially if OpenAI goes public. I actually don't know how that's going to play out for Microsoft because suddenly all of Open AAI's books are going to be available to everybody and we don't really know how much revenue they have and all of that stuff. And if their revenue is not great that they can afford $280 billion with Microsoft alone, if they can't really afford that, I just don't know how the market's going to react to that. So, this may get a little bit bumpy along the way. Now, we actually do a daily every day the market is open, we do a newsletter that goes out in the morning before the market's open. It's free to sign up for if you're curious. I will leave a link in the description below to sign up to get access to that. And thank you so much for sticking with me all the way to the end of the video. I really do appreciate it. Thank you and I'll see you in the next video.