MSFT Stock is Crashing - Is It Time To Buy?

[00:00:00] Speaker 1: So Microsoft stock has been absolutely crashing, and I think that this is not a dramatic statement to make right now because Microsoft is down 34% from its all-time highs. It's down 25% just over the past month. It was down another 4% at the lows today, and the stock has now produced almost no returns since the end of 2021. And this is at the same time as the business's underlying fundamentals are continuing to grow extremely well. But the market does not like Microsoft stock right now, and this has caused many of you to ask me for my opinion on Microsoft if I think the stock is looking attractive today, and ultimately if I am buying it. So in this video, we are going to be discussing all things Microsoft stock, and I think that we should start off by discussing the main bear arguments against the stock right now because, again, investors are clearly not excited about it. And there are three main bear arguments that I have been able to identify. These main bear arguments are that AI is going to disrupt their software business, that their CapEx is not going to pay off, especially with the rising cost of chips. I mean, just take a look at Micron and how much they're selling their memory for now. And the third bear argument is Microsoft's reliance on OpenAI for its cloud business growth, since 45% of its remaining performance obligations are coming from OpenAI. So let's now break down these three main bear arguments one by one, and let's start off from the top with AI eating Microsoft software business. Well, first off, Microsoft has been moving more towards usage-based pricing and not just seat-based pricing. It's also becoming more model agnostic and not just relying on OpenAI's one model for their software company to succeed. Microsoft software is also deeply embedded in enterprise workflows, and they have tons of proprietary data to add value to their existing customers across the globe. From everything that I have been reading about artificial intelligence so far, distribution plus proprietary data is where the moats are going to live in an AI world, as large language models continue to become commoditized. And the fact that Microsoft has such large distribution across the globe, plus so much proprietary data on business workflows makes me believe that they will actually be a winner and a beneficiary from artificial intelligence and not be disrupted by it. I actually think that they have a very defensible position in the software business. Now, in addition to that, in Microsoft's most recent quarter, they said that their AI revenue was up 123% year-over-year to $37 billion. Copilot also came in at 20 million paid seats, with paid seats up 250% year-over-year. And lastly, the number of customers that were paying for over 50,000 copilot seats quadrupled on a year-over-year basis. So enterprises are adopting copilot more. But it does still seem like Microsoft needs to continue improving copilot overall, as the percentage of customers paying for copilot is still pretty low, at around 4%, I believe was the last metric. But their AI business is growing strong, and it seems like it is being a tailwind for the overall company. Microsoft's productivity and business processes revenue, which is mostly comprised of their software business revenue, is sitting at an all-time high of $135 billion in revenue over the trailing 12 months, and it is still compounding by about 14% annually. So it does not seem like Microsoft's software segment is being disrupted by artificial intelligence, and it's still growing very well. Now, moving on to the second bear argument, once again, this is that capital expenditures are not going to pay off for Microsoft, especially while chip prices are rising. And I am sure that we all know that capital expenditures are very high right now across all of the hyperscalers. And it seems like the market is becoming more and more concerned and worried that this capex is not going to produce a high return on investment, especially again, now that chips are becoming more and more expensive. For example, if a billion dollars spent a year ago used to buy you a billion chips, again, just as an example, that same $1 billion today may get you half a billion chips. So hyperscaler dollars are clearly not going as far as they once were. And I also think that's why hyperscalers across the board are selling off again today in the markets after Micron's earnings report, because Micron is clearly continuing to raise prices. And they're saying that prices are going to be higher for longer than people may think. And if chip prices are going to remain elevated, then again, hyperscalers are not going to get the same ROI. So I do believe that the hyperscaler ROI is arguably coming down. But I also believe that their ROI on this capex is still going to be very attractive, because every single one of them is saying that they are capacity constrained. There is so much demand for cloud computing for AI computing for tokens, that they literally cannot meet this demand. That is why they all want to build data centers and compute as quickly as possible, because they see so much demand, and that demand is right there. All they have to do is capture it, but they don't have the capacity to do so. And I believe that the people running these businesses, you know, the some of the largest companies in the world, know what they're doing, especially with Amazon, since they have operated AWS and their cloud computing business for over a decade now, well over a decade, they know what they're doing. And they know what the cash flows of these data centers look like. And personally, I do not believe that the demand for AI is going to slow down at all. I mean, I had the chance to play around with mythos before it became banned up here in Canada. And that model was genuinely insane. Someone in my discord gave mythos a three sentence prompt to analyze a stock, which was Tasmania. And it generated a 44 page, beautiful research report on Tasmania, where every metric was accurate, the numbers were all correct. And it was extremely valuable. It would have taken me over 20 hours to consolidate all of that research into a nice PDF. And mythos did it in probably like 15 minutes. The amount of value from that one research report was tremendous. And that's just with one example of a stock report. So I believe that the value of artificial intelligence is very real. That demand is also very real. The one concern lately has been the cost of AI. But what's also ironic is as the hyperscalers continue to build out their supplies, then the cost of artificial intelligence should come down, which should actually increase the usage and potentially even increase the hyperscalers revenues from AI. So I don't think that the cost concerns around AI are necessarily a long-term risk. And again, as the cost of AI continues to come down, I actually think that its usage and adoption will continue to spread further and further. But getting back over to the return on investment worries here, we can see that Microsoft's operating cashflow margin is actually at a more than decade high of 53.5%. However, Microsoft's free cashflow margin is a lot lower right now because they are in the very large CapEx cycle. But the underlying operations of the business are still very profitable. Again, the operating cashflow margin is at an all-time high. And this next screenshot shows us that operating cashflow growth is still very strong and hit an all-time high of $170 billion in the trailing 12 months. It's also continuing to compound by roughly 18% per year. So Microsoft's underlying operations are getting more and more profitable. They're producing more and more cash and it is growing tremendously. And once the CapEx cycle eventually slows down, which I think is simply an eventuality, I mean, these companies are not going to be spending 100% of their operating cash flows on CapEx forever. I do believe that this is just a cycle. And again, once that cycle slows down, then these companies' free cash flows, in my opinion, are going to absolutely explode. And I also believe that Microsoft's operating cashflow growth is showing us that they are getting a positive ROI on all of their CapEx spend. Because again, their operations are producing more real cash. So now let's move on to the third and final bear argument that is very loud right now. And that is Microsoft's reliance on OpenAI for cloud growth. And the reason there is so much worry about Microsoft's reliance on OpenAI is because 45% of the remaining performance obligations are coming from OpenAI. However, Azure's 40% growth is not solely an OpenAI story. And Azure has been growing tremendously, even if you remove OpenAI altogether. In the most recent quarter, Microsoft's CFO pointed out that the remaining 55% of the remaining performance obligations still grew 28% year over year. So Microsoft's non-OpenAI remaining performance obligations and business is still growing by nearly 30% on a year over year basis. She also highlighted that OpenAI gets a very cheap compute from Microsoft. So OpenAI's cloud computing revenue in specific is lower margin and not actually benefiting the underlying profits of the business all that much compared to its other enterprise customers. So now let's take a look at Microsoft's cloud operating income. And we can see that it is at an all-time high in the trailing 12 months of $53 billion, and it's been growing by roughly 26% annually. So to put it simply, Microsoft's cloud business is growing very strong, it's highly profitable, and its non-OpenAI remaining performance obligations are still growing very well too. I actually think that if you deleted OpenAI from the equation altogether, then Microsoft's cloud would still be growing very well and would still be capacity constrained. And that ultimately leads me to believe that this bear argument and fear over OpenAI is overblown. So now let's take a quick look at some of Microsoft's first quarter 2026 earnings reports highlights. And here we can see that the overall revenue for the business was up 15% on a constant currency basis. Operating income was up 16%. And then Satya said, we are focused on delivering cloud and AI infrastructure and solutions that empower every business to eval max their outcomes in an agentic computing era. Our AI business surpassed an annual revenue run rate of $37 billion, up 123% year over year. So in the most recent quarter, Microsoft's business is still growing well into the double digits. Its cloud business is doing extremely well. And the AI business again, more than doubled year over year. Moving on to the next screenshot, this one shows us that Microsoft 365 commercial cloud revenue increased by 15%. Microsoft 365 consumer cloud revenue increased by 29%. LinkedIn revenue increased by 9%. And Dynamics 365 revenue increased by 17%. Then down at the bottom, we can see that Azure software in specific increased by 39%. This is Microsoft's software and cloud business segments right here. And across the board, they are growing by double digits well into the double digits. So once again, it doesn't seem like their cloud business is suffering. And their software business is also performing very well. However, this next screenshot shows that Microsoft's more personal computing revenue came in at 13.2 billion, and actually declined by 3% year over year on a constant currency basis. Windows OEM and devices revenue was down 3%. Xbox revenue was down 7%. And search and advertising revenue was up only 9%. And honestly, the more personal computing segment of Microsoft's business is really not that exciting. And it's not growing that quickly. However, the good news is that the more personal computing segment is not that much of a profit contributor to Microsoft's overall business. In the trailing 12 months, it only produced $15 billion of operating income. Microsoft's total business produced about $149 billion. So the more personal computing segment is around 10% of the company's overall profits. And as time passes, it's becoming a lower and lower net contributor as the cloud business and software businesses continue to grow extremely well. So in my opinion, the Microsoft thesis really relies on the cloud and software businesses and those businesses continuing to perform well. So now let's start to discuss Microsoft's valuation quickly here. And I like to take a look at these companies price to operating cash flows right now, because all of the hyperscalers are in a massive capex investment cycle. So taking a look at free cash flow is going to be a mistake, at least in my opinion. And Microsoft's price to operating cash flow is around 15.3 right now. This is below where it traded for during the sell-off of 2022, when it got down to about 19 times operating cash flow. And during the stock market crash of 2020, the price to operating cash flow got down to about 19. So Microsoft is trading for a lower price to operating cash flow right now than during the bear market of 2022. And during the stock market crash of 2020, we actually have to go all the way back to 2017 to find a similar price to operating cash flow. So on an operating cash flow basis, Microsoft is now near a decade low, which I think is pretty incredible. Now what's also incredible is if we go take a quick look at Microsoft's revenue back in 2017, the business was really not growing all that much when it was last trading for a similar price multiple. You can see that from 2015 to about 2017, the revenue only grew by roughly 3%. And again, this was the last time that Microsoft was trading for a similar price multiple. If we zoom out, you can see that the business is clearly continuing to grow strong right now, and its revenue growth rates are actually accelerating slightly. So let's now take a look at Microsoft on a forward PE basis. And right now it is trading for a forward PE of under 19, basically right around 19. And once again, in 2022, it was trading for about 21.6 times forward earnings. And then during the stock market crash of 2020, it got all the way down to about 22 times forward earnings. The last time that Microsoft was trading for a similar forward PE multiple was once again all the way back in 2017. So even on a forward PE basis, it is trading for around a decade low. And this suggests that the market is not bullish on Microsoft at all right now. And the sentiment towards this company is pretty terrible. So lastly, let's run some quick DCFs on Microsoft. And in this DCF, I am projecting out the operating cash flow over the next three years. And I'm saying that it will grow by 13% annually, which is well below the company's current growth rates of around 18% operating cash flow. I am also saying that Microsoft will trade for about 18 times operating cash flow. And if we take a look at their median over the past decade, it was actually about 22. So this is not even factoring in the business getting back to its historical average multiples. So to put it simply, I think that Microsoft could actually trade for a higher multiple and see more growth in the future. And even with this more conservative DCF, we get a 20% compounded annual growth rate to the share price, a fair value of $460, and a future stock price of $600 by 2029. So in this more conservative DCF right here, it looks like Microsoft could produce some pretty strong returns, as long as the business's operating cash flows and underlying profits can continue to grow, which I think they will. All right, so my camera died. So I will be doing my summary just here on the computer with a bullet point. So overall, I do think that Microsoft is looking very undervalued and very, very cheap right now. The market is clearly bearish towards open AI, software, and the hyperscaler spending. And Microsoft is the poster child of all three of these bear arguments right now in the market. And I think that's why the stock has been underperforming so much. But the underlying business and the fundamentals are continuing to grow and compound. And over the longer term, as an investor, I think that this is really all that will matter. So once the hyperscalers slow down their CapEx spending, which I think is an eventuality, and this CapEx spending they're doing right now cannot last forever, I think the free cash flow will explode, but this will take time. And right now, it does not seem like any of them are planning on slowing down their CapEx. In the meantime, the market has become less bullish and more worried about the CapEx expenditures. The market has clearly rotated more into the memory and chip stocks instead, and has left the hyperscalers behind now. I don't think that these are bad businesses at all, though. And as we saw, Microsoft's underlying profits and operating cash flows are growing, the revenue is compounding, and the business is actually accelerating right now. With that said, I have not added any Microsoft shares yet, as I do not have a lot of cash in my portfolio right now after buying so much Amazon and Meta and some other stocks in my portfolio. But I am very tempted to also add some Microsoft, it just means that I would have to trim something else down to do so at this very moment. As again, I do not have a lot of cash. But I am right on the edge of doing this, I just don't necessarily know what I would trim down to add Microsoft. But I do genuinely think that Microsoft looks like it is undervalued. And when I run DCFs on it, it doesn't have to perform that well, like the underlying business doesn't have to perform that well from here, to produce a pretty stellar return. And this is Microsoft we're talking about. This is one of the best businesses in the world, with the widest distribution of enterprise customers. And if I had to bet on any company figuring out wide distribution, corporate software revenue, and usage based world, it would be Microsoft. But let me know what you think down in the comment section below. Do you think that Microsoft is looking cheap here? Are you buying it? Do you think that I should? I would love to discuss with you. But with all that being said, that's going to wrap up the video for today. So if you enjoyed the video, then please remember to leave a like on it. And if you're new here, then please consider subscribing to my channel if you want to see more content like this. And as always, I truly appreciate you taking your time to watch my video, and I hope to see you again in the next one.