Microsoft’s (MSFT) - Get Free Report valuation has been hit hard these past few weeks, as investors become fearful over what was initially viewed as a temporary public health situation in China, with investors now bracing themselves for a global recession.
However, as the world continues to digitize, Microsoft’s leadership in numerous critical verticals means that it's very well suited to navigate the economic downturn. As investors flee to safety, Microsoft makes for a highly compelling investment. Here’s why:
It Started Badly and Rapidly Got Worse
Microsoft ended fiscal Q2 2020 with $74 billion in net cash. Given Microsoft’s present share price, shareholders may feel upset that Microsoft deployed $5.2 billion towards share repurchases during the previous quarter. But at the time, coronavirus was a fairly localized issue. Nobody could have predicted the ravaging it would have on global economies within a matter of weeks. However, that’s the advantage of investing in well-managed, best-of-breed businesses: these companies adopt a safety-first approach.
How Big an Impact Will Coronavirus Have on Microsoft?
A few weeks ago, Microsoft noted that the coronavirus would have a negative impact on its More Personal Computing segment, which is responsible for roughly a third of its total revenues and includes Windows OEM and Surface revenues.
Realistically, we should now expect Microsoft’s near-term operations to be further impacted. Last quarter, Microsoft positively surprised many analysts with its revenue growth, driven by strength in Azure’s operations. Azure’s revenues grew by 64% (currency-adjusted), driven by strong growth in its consumption-based business.
However, similar to Adobe’s report last week, where it noted that customers were deferring bookings, investors should expect Microsoft to be in a similar position with enterprises reducing their cloud-based consumption as businesses cut back on non-essential operations.
Valuation - Large Margin of Safety
It's one thing to say you should buy when there’s blood on the street, and another to do in practice. Investors want to be rewarded for their boldness in these difficult times. They will be tempted to try to time the lowest share price before deploying key savings -- just it’s human nature.
However, a slightly better approach is to buy great companies when there is widespread panic while being cognizant that perfectly timing the market is impossible, Down the line, today’s share price will look cheap in hindsight.
Indeed, given Microsoft’s strong and consistent share repurchases, Microsoft’s GAAP EPS is growing with a three-year compounded annual growth rate in the mid 30s percent. And at the moment, its P/E has come down to less than 26x.
The Bottom Line
Investors are in panic mode and prepared for a global recession.
However, Microsoft earnings are being undervalued at roughly 26 times, even though Microsoft’s operations are hugely diverse, and its balance sheet holds astonishing amounts of cash. These factors make it perfectly positioned to capitalize on numerous opportunities that will unfold in the coming weeks, either through further share repurchase of its own stock or to acquire strategic peers at bargain prices.