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Buy the Dip After Microsoft’s Earnings Report

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Technology giant Microsoft (NASDAQ:MSFT) reported fourth-quarter numbers in late July that breezed past expectations and were, from head to toe, very good.

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But MSFT stock dropped in response to the strong print.

Why?

There was some selling-the-news and profit-taking on the heels of an enormous 50% rally over the past four months. Nothing more.

Zooming out, the quarter was good. The fundamentals remain rock solid. The growth drivers remain strong. And the valuation on MSFT stock remains tangible relative to the company’s long-term growth prospects.

So, buy the dip. Here’s a deeper look.

Strong Microsoft Earnings

Microsoft’s fourth-quarter earnings were a strong ending to a record year for the technology company.

Revenues rose 15% year-over-year on a constant currency basis, breezing past expectations on the back of supercharged demand for the company’s cloud infrastructure, productivity and communications services thanks to the novel coronavirus pandemic.

Office 365 commercial revenues rose 22% year-over-year. Dynamics 365 revenues rose 40% year-over-year. Azure revenues rose 50% year-over-year. The number of organizations on Microsoft Teams with over 100,000 users more than tripled quarter-over-quarter, from 20 to 69.

Meanwhile, operating profits rose 12% year-over-year on a constant currency basis. Earnings per share also breezed past expectations.

Drivers were big revenue growth, healthy gross margins and solid expense control.

The one negative: the first quarter revenue guide did come in light, hampered mostly be a shaky broad economic outlook for enterprise spending over the next three months.

But that’s just near-term noise. Enterprise spending trends will rebound once pandemic-charged economic disruptions fade.

In the bigger picture, looking past the first quarter of 2021, enterprise spending on cloud infrastructure, productivity and communications services will soar over the next few quarters and years as organizations adjust to the “new normal,” which includes a hybrid model of remote work and in-office work, and is built on the back of the cloud.

As that happens, Microsoft will continue to report steady, double-digit constant currency revenue and profit growth rates. Such steady growth paves the path for MSFT stock to keep pushing higher.

MSFT Stock Remains Reasonably Valued

Relative to the company’s promising growth prospects, Microsoft stock is reasonably valued.

Here’s the math.

Enterprise cloud spending trends will be the primary fuel for Microsoft’s revenue growth over the next several years. But, also factoring in there will be increased video game engagement boosting the Xbox business, and a recovery in digital ad spending sparking reinvigorated growth at LinkedIn and in the Bing search business.

Connecting all the dots, it seems quite likely that Microsoft sustains 10%+ revenue growth for the next five years. Gross margins should improve as the company’s cloud businesses scale. Concurrently, Microsoft’s operating expenses have grown at a 6% compounded annual growth rate over the past five years, so 10%+ revenue growth should drive positive operating leverage.

Steady 10%+ revenue growth on top of margin expansion drivers should power somewhere around 15% profit growth over the next five years.

Assuming so, my modeling pegs fiscal 2026 earnings per share at $13. Based on a systems software sector-average 25x forward earnings multiple and an 8.5% annual discount rate, that implies a fiscal 2021 price target of $235.

Thus, I think MSFT stock has fundamentally supported upside potential of 15% over the next 12 months, which is pretty good in an environment with a sub-1% 10-year Treasury yield.

Bottom Line on MSFT Stock

Microsoft stock is a long-term winner. And the company’s fourth quarter earnings report was pretty good.

Post-earnings weakness here and now is just some investors doing some profit-taking after a huge rally over a short period of time.

Let them do their profit-taking. Let the weak hands shake out. Then buy the dip in MSFT stock around $200.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long MSFT.

The post Buy the Dip After Microsoft’s Earnings Report appeared first on InvestorPlace.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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