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Here’s Why Microsoft Shares Could Be Headed Much Higher

October 27, 2016, 7:48 PM UTC
Ciara, Kat Graham, Lilly Singh, The Band Perry, Paula Abdul, George Takei, Marlee Matlin And More Come Together At WE Day Seattle To Celebrate The Power Young People Have To Change The World
SEATTLE, WA - APRIL 20: Microsoft CEO Satya Nadella speaks on stage during We Day at KeyArena on April 20, 2016 in Seattle, Washington. (Photo by Mat Hayward/Getty Images for We Day)
Photograph by Mat Hayward—Getty Images for We Day

Microsoft is, finally, partying like it is, well, the late 1990s.

Last week, shares of Microsoft (MSFT) rose above $58 for the first time since 1999. The stock is up nearly 21% in recent months, including 5% last Friday alone after the company’s most recent earnings announcement, and now trades at just over $60.

Along the way, the ride for investors has been a rollercoaster with a long lull in the middle. The stock was as low as $16 in 2009. For most of the oughts it was stuck in the 20s.

And with the run up in its stock price, Microsoft’s stock valuation has pushed higher and higher. Microsoft’s price-to-earnings multiple is now higher than the market in general, and higher than it has been in years. So are Microsoft’s shares still worth uploading to your portfolio?

First of all, the company is a lot different from what it was last time the stock was near $60 a share. In 1999, Microsoft had revenue of nearly $20 billion and earnings of $7.8 billion. These days the company generates $85 billion in annual revenue and it earned just over $16.5 billion in the past twelve months as of Sept. 30.

So despite being at the same price and market cap of $460 billion, Microsoft’s shares currently carry a price/earnings ratio of 29, or less than half of the 79 they traded for in 1999.

Nonetheless, that doesn’t necessarily mean Microsoft’s shares are cheap now. Figuring that out is in fact more difficult these days than it was two decades ago, when most of Microsoft’s earnings came from one product, Windows. But one way to do it is to take a closer look at the different and much more diverse business lines of today’s Microsoft, and see how investors are valuing their competitors in those businesses.

Microsoft reported better than expected earnings last week. What seems to have pulled the company out of its multi-year slump lately, though, is not a Windows revival but the company’s push into the cloud. Microsoft’s cloud division, which didn’t even exist a few years ago, now generates $25 billion a year. Of course, the cloud—shared storage and virtual operating systems—along with big data, is among the buzz areas of the computing business these days. And lots of tech giants want in, from retailer Amazon (AMZN) to consumer management software developer Salesforce (CRM).

Salesforce trades at a price-to-sales ratio of nearly 7. That’s higher than Microsoft’s overall price-to-sales ratio of 5.5, but again what matters is how Microsoft’s individual product lines should be valued. What’s more, Microsoft’s cloud services include software tools as well as computing power and storage, so it’s not exactly comparable to Salesforce. However, based on Salesforce’s valuation Microsoft’s cloud business, by itself, could be worth nearly $170 billion.

Microsoft still generates about $31 billion annually from its Windows operating system and office software (Word, Excel, etc.). That business has shrunk in the past few years, but it’s still valuable. Perhaps a good comparison for that is Oracle, which generates about $37 billion mostly from software sold to businesses. Oracle’s shares (ORCL) trade at a price/sales ratio of nearly 4; at that price, that would be another $124 billion in value for Microsoft.

On top of that, Microsoft generates about $13.5 billion a year from Xbox and Surface tablets, which Microsoft puts in its personal computing segment. Give that a roughly 3-times-sales, Apple-like multiple and that’s another $40 billion. There’s also another $6 billion that Microsoft generates from advertising. Google (GOOG) is the king of internet advertising, and its stock trades at a sales multiple of 13, which would value that portion of Microsoft’s business at nearly $80 billion.

Lastly, Microsoft has about $10 billion from providing business services, as well as server products and tools. Value that like IBM (IBM) and that part of Microsoft’s business should be worth another $20 billion.

Put that Salesforce-Oracle-Google-Apple-IBM mash-up together, and you get a total value for the company of roughly $435 billion or about $30 billion less than where Microsoft is currently trading. That means the market isn’t anticipating much growth from the company. It’s valued at what the company’s business lines are worth now.

And that could be because Microsoft hasn’t grown much in the past few years. Sales dropped 7% last year. But that appears to be changing, as the company’s pivot into cloud services gets more momentum. Sales growth was 5% in the most recent quarter, and expected to be up in the double digits by the end of this year.

Of course, Microsoft’s revenue growth was consistently above 25% back in 1990s. If it grew at even half that pace, Microsoft’s stock could be worth as much $79, which is 30% above where it’s trading now.

Party on.