Microsoft Stock: Bear vs. Bull

Microsoft (NASDAQ: MSFT) posted its latest earnings report on Oct. 24. For the first quarter of fiscal 2024, which ended on Sept. 30, the tech giant's revenue rose 13% year over year to $56.5 billion and beat analysts' estimates by $1.95 billion. Its EPS grew 27% year over year to $2.99 and also easily cleared the consensus forecast by $0.34.

Microsoft's headline numbers were impressive, but does the stock still have room to run after rallying nearly 40% already this year? Let's review the bear and bull cases for this tech bellwether to see where its stock might be headed.

Image source: Getty Images.

The key numbers

During the first quarter, Microsoft generated 43% of its revenue from its Intelligent Cloud segment, which houses Azure's cloud infrastructure platform, its other cloud services, and its other server products. Another 33% of its revenue from its Productivity and Business Processes division, which handles Office, Dynamics, and LinkedIn.

The remaining 24% of its revenue came from its More Personal Computing division, which handles Windows, Xbox, Surface, Bing, and its digital advertising businesses. Here's how its three core businesses fared over the past year.

Data source: Microsoft. YOY = Year over year.

The Intelligent Cloud segment continued to grow rapidly as Azure benefited from the growth of the machine learning and artificial intelligence (AI) markets. Microsoft's investments in OpenAI also enabled it to integrate ChatGPT's tools into its cloud-based services. The Productivity and Business Processes segment experienced accelerating sales growth as Office and Dynamics locked in more enterprise users.

The growth of those two segments offset the sluggish growth of its More Personal Computing segment, which struggled as slow PC sales curbed the market's demand for new Surface devices and Windows licenses.

Why the bears think Microsoft's upside is limited

The bears believe Microsoft will suffer acquisition indigestion as integrates its recent $69 billion acquisition of Activision Blizzard into its Xbox division. That acquisition adds hit franchises like Call of Duty, World of Warcraft, Diablo, and Candy Crush to its gaming portfolio, but Activision had been struggling with sluggish growth, product delays, and sexual harassment scandals prior to its takeover. If Microsoft fails to fix those issues, it could become a dead weight on its More Personal Computing segment and offset the growth of Xbox's other gaming divisions.

Another potential landmine is its growing exposure to OpenAI, which could be valued at a whopping $86 billion after its next private stock sale. Microsoft is currently OpenAI's biggest backer, but that massive investment could backfire if the AI bubble pops. In a worst-case scenario, OpenAI could crush Microsoft's net profits in the same way Amazon's investment in the EV maker Rivian resulted in an ugly net loss in 2022.

The bears also think Microsoft's stock is a bit pricey at 30 times forward earnings, and that its forward dividend yield of 0.9% won't attract any serious income investors -- especially when most CDs pay 5%-6% yields.

Why the bulls believe Microsoft still has room to run

The bulls will acknowledge the challenges of integrating Activision Blizzard, but they'll also point out that Microsoft has integrated plenty of other gaming giants -- including ZeniMax, Obsidian, and 343 Industries -- in the past. Over the long term, the acquisition of Activision should widen Xbox's moat against Sony and Nintendo with more exclusive games while expanding its library of games for its Game Pass and Xbox Cloud Gaming services.

But more importantly, the bulls believe the expansion of Azure, the beating heart of its cloud business, will continue to offset the slower growth of its other business divisions. Its Azure and other cloud services revenue rose 29% year over year in the first quarter and actually accelerated from its 26% growth in the fourth quarter.

That means it's in much better shape than its closest competitors. In their latest quarters, Azure's larger rival Amazon Web Services (AWS) only grew its revenue by 12% year over year, while Alphabet's smaller Google Cloud Platform (GCP) reported just 22% year-over-year revenue growth. Azure's stronger growth suggests the integration of OpenAI's generative AI tools into its cloud platform is giving it a competitive edge in the cutthroat cloud platform market.

Lastly, Microsoft's insiders seem confident in its growth potential. Over the past three months, they bought nearly 50% as many shares as they sold -- even as high interest rates weighed down the broader tech sector.

Which argument makes more sense?

Microsoft might still face some near-term challenges, but the accelerating growth of its cloud business should offset most of its weaknesses. Its stock might not seem like a bargain right now, but I believe its robust growth rates, diversification, and shrewd AI investments all justify its premium valuation and make it a great long-term buy.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has positions in Alphabet and Nintendo. The Motley Fool has positions in and recommends Alphabet and Microsoft. The Motley Fool recommends Nintendo. The Motley Fool has a disclosure policy.