Is Analysts' Sentiment For Microsoft Corporation's (NASDAQ:MSFT) Justified?

Microsoft Corporation (NASDAQ:MSFT)’s outlook is one of buoyant sentiment as it continues to post exciting top-line revenue growth. However, my main concerns are around how the company is managing its balance sheet, and whether their current financial status is sustainable. In addition to this, it seems like the market is overly optimistic about the business, with is shares trading above its fair valuation. I will touched on some key aspects you should know on a high level, around its financials and growth prospects going forward.

Microsoft Corporation develops, licenses, and supports software, services, devices, and solutions worldwide. Founded in 1975, it currently operates in United States at a market cap of US$838.75b.

NasdaqGS:MSFT Future Profit September 12th 18

The company is growing incredibly fast, with a year-on-year revenue growth of 14.3% over the past financial year . In the last five years, sales has increased by 5.0%, concurrent with larger capital expenditure, which most recently reached US$11.63b. An expected return on investment of 36.6% over the next three years is a result of MSFT’s reinvestment into the business, according to the consensus of broker analysts covering the stock. Net income is expected to grow to US$32.84b over the next year, exceeding the industry average growth rate of 22.3%. In addition, over the next five years, earnings are predicted to grow at an annual rate of 20.4% on average. These numbers tell me that MSFT has a robust history of delivering profit to shareholders, with a disciplined approach to reinvesting into the company, and a bright future relative to its competitors in the industry.

NasdaqGS:MSFT Historical Debt September 12th 18

MSFT’s financial status is a key element to determine whether or not it is a risky investment – a key aspect most investors overlook when they focus too much on growth. A big red-siren warning for MSFT is its high level of debt, which has been increasing over the past five years, exceeding its total level of equity. However, cash generated from its core operating activities makes up a decent portion of debt (0.5x), and it generates enough earnings to cover its annual interest payments. But there’s still room for improvement on the debt level front, which could be lowered to a more prudent amount. The current state of MSFT’s financial health lowers my conviction around the sustainability of the business going forward. MSFT has high near term liquidity, with short term assets (cash and other liquid assets) amply covering upcoming one-year liabilities, as well as long-term commitments. One reason I do like MSFT as a business is its low level of fixed assets on its balance sheet (15.0% of total assets). When I think about the worst-case scenario in order to assess the downside, such as a downturn or bankruptcy, physical assets and inventory will be hard to liquidate and redistribute back to investors. MSFT has virtually no fixed assets, which minimizes its downside risk.

MSFT currently trades at US$111 per share. With 7.67 billion shares, that’s a US$838.75b market cap – which is expensive for a company that has a 5-year cumulative average growth rate (CAGR) of 3.5% (source: analyst consensus). With an upcoming 2018 free cash flow figure of US$36.63b, the target price for MSFT is US$66.43. Therefore, the stock is trading at a premium. But, comparing MSFT’s current share price to its peers based on its industry and earnings level, it’s trading at a fair value, with a PE ratio of 51.69x vs. the industry average of 50.77x.

In order to invest in MSFT, you have to believe in its growth story, which is a strong one. However, my main reservation with the company is its financial health, as well as the possibility that it is currently overvalued. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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