In investing, I believe a few characteristics are essential to achieving optimal investment outcomes. One key trait is a track record of consistency. By that, I mean that it must consistently grow earnings each year. A prospective investment must also possess an investment-grade credit rating, limiting insolvency risk. The underlying stock must also be sensibly valued. By these accounts, Microsoft (MSFT) could be interesting here.
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The company has posted diluted EPS growth in its last nine fiscal years, with more double-digit growth likely. As I’ll outline, Microsoft is also a financial fortress. Finally, shares look to be trading near fair value. For those reasons, I’m bullish on MSFT stock and assign a Buy rating.
Microsoft Exceeds Expectations Again in Q3
On October 30th, Microsoft shared Fiscal Q1 2025 earnings results, backing up my Buy rating. The company’s total revenue surged 16% higher over the year-ago period to $65.6 billion during the quarter. That exceeded the analysts’ consensus by approximately $1 billion for the quarter. This was driven by a 22% uptick in Microsoft Cloud revenue to $38.9 billion (including Microsoft 365 Commercial Cloud, Azure, other cloud services, the commercial portion of LinkedIn, and Dynamics 365). Additionally, Microsoft’s diluted EPS climbed 10.4% year-over-year to $3.30.
This was the seventh consecutive quarter that Microsoft delivered a double beat. Faster growth in the total cost of revenue expense line (+23.3%) to $20.1 billion resulted in a 180-basis point contraction in the net profit margin to 37.6%, which caused the diluted EPS growth rate to lag the total revenue growth rate.
The Growth Outlook Is Promising for Microsoft
Another element behind my Buy rating is that the company’s growth forecast is encouraging. There are at least a couple of reasons for my optimism toward future operating results. For one, CFO Amy Hood noted in her opening remarks during the Q1 2025 earnings call that commercial bookings on the Microsoft Cloud platform outpaced expectations, up a reported 30% and 23% in constant currency over the year-ago period. This was thanks to strong growth for $10 million-plus contracts for Azure and Microsoft 365 and growth in $100 million-plus contracts for Azure. This momentum bodes well for the near future.
Zooming out, the macro picture is just as positive. Microsoft is a leader in the cloud computing market and is also expected to grow rapidly. Continued business adoption of cloud computing is expected to help the market compound by 15.1% annually, from $626.4 billion in 2023 to nearly $1.3 trillion by 2028, per the research firm Markets and Markets. Additionally, RobinHood (HOOD) pointed out that the company’s AI business is on pace to surpass an annual revenue run rate of $10 billion in Q2. Just two and a half years in, this will make it the fastest business in Microsoft’s history to reach that milestone.
As more companies integrate AI into their operations, this business should also have ample room to grow.
Based on these fundamentals, the analysts’ consensus is that Microsoft’s diluted EPS will rise by 10.2% in FY 2025 to $13. Another 15.6% increase in diluted EPS to $15.03 is expected for FY 2026. In FY 2027, the current analyst consensus is an additional 18.2% jump in diluted EPS to $17.77.
Microsoft Pays a Quickly Rising Dividend and Sports an Impressive Balance Sheet
Microsoft’s quarterly dividend is another reason for my bullishness. The stock’s 0.7% dividend yield registers marginally higher than the tech sector average. Microsoft’s payout ratio is also set to be in the mid-20% range for FY 2025, which should help it to hand out more double-digit dividend raises in the future. For my money, this makes the stock a compelling play for dividend growth in the years ahead.
Another appealing attribute of Microsoft is its balance sheet. As of September 30th, 2024, the company had a net cash and marketable securities balance of $33.3 billion. Thus, Microsoft recorded a net interest income of $99 million in Q1 2025. That explains why the company enjoys a flawless AAA credit rating from S&P Global (SPGI) on a stable outlook. Besides Johnson & Johnson (JNJ), Microsoft is the only other company that can claim to have achieved this feat.
The Valuation Is Reasonable
Microsoft’s vigorous operating fundamentals also don’t come at the cost of an excessive valuation, another factor for my Buy rating. The company’s 12-month forward P/E ratio of 32.1 comes in a hair below the five-year average P/E ratio of 33.1. I believe that the five-year P/E ratio represents fair value for Microsoft. That’s because the company’s forward diluted EPS growth prospects remain in the mid-teens annually. This implies that Microsoft’s fair value is around $460 a share, which is a modest discount compared to the current share price. As time goes on and more of my fair value estimate hinges on FY 2026 estimates, this fair value should continue to climb higher.
Is Microsoft Stock a Buy, According to Analysts?
Shifting to Wall Street, analysts have a Strong Buy rating consensus on Microsoft. Among 26 analysts, 24 have assigned Buy ratings, and two have issued Hold ratings in the past three months. The average 12-month price target of $499.19 suggests a 10.54% upside from the current share price.
Conclusion
Microsoft is arguably one of the world’s most dominant businesses. The company is an industry leader in rapidly growing markets led by cloud computing. This should bode well for future earnings growth. Microsoft’s balance sheet is remarkable. Lastly, the stock is priced at a rational valuation. Thus, my Buy rating.
