To The Moon

$Microsoft(MSFT)$

Microsoft’s stock has declined by over 8% year-to-date in 2025, leaving investors wondering whether it presents a buying opportunity despite its underperformance this year. However, the company continues to excel in several key areas, particularly its cloud computing segment, which provides computing services to OpenAI’s ChatGPT.

In this article, I will analyze Microsoft’s revenue growth in recent years, profit margins, and returns on investor capital. Additionally, I will assess the stock’s valuation, including my proprietary discounted cash flow analysis, as well as its forward price-to-earnings and price-to-free-cash-flow ratios. By bringing all these factors together, I will provide an updated recommendation on Microsoft stock.

Earning Overview

Microsoft’s revenue growth has slowed slightly in the most recent quarter, but it remains in double digits at 12.4%. The company has consistently delivered revenue growth above 10% per quarter, and I expect it to sustain this level for several more years.

One of Microsoft’s strongest growth drivers is its cloud computing division, which is expanding at nearly 30% annually. This growth is largely fueled by the increasing effectiveness and adoption of artificial intelligence (AI). Microsoft currently ranks second in cloud computing, trailing only Amazon, whose cloud business continues to thrive at scale. As businesses continue shifting from on-premises computing to cloud-based solutions, the long-term potential for Microsoft’s cloud division remains substantial.

Additionally, Microsoft is launching a new version of Windows while phasing out support for an older version. This transition could drive a short-term boost in PC sales over the next two to three years. However, the longer-term revenue driver will remain cloud computing.

Fundamental Analysis

Perhaps even more impressive than Microsoft’s revenue growth is its improvement in operating profit margins. As shown in the accompanying chart, Microsoft’s operating margin stood at 30% in 2016—a strong figure in itself. Since then, it has improved by 50%, reaching 45% over the past 12 months. This demonstrates the company’s ability to scale profitably while maintaining double-digit revenue growth.

That said, some investors are concerned about Microsoft’s operating margins due to its heavy investments in AI. The company spent $50 billion last year on capital expenditures, primarily to expand its AI infrastructure. In 2025, Microsoft plans to increase this spending to $80 billion, again focusing on AI infrastructure development. These investments are already putting some pressure on margins and could pose a long-term constraint unless AI-related revenue growth outpaces spending.

Microsoft’s management has repeatedly stated that this level of AI investment is driven by overwhelming customer demand. They emphasize that supply is currently the limiting factor, not demand. As long as this dynamic holds, Microsoft’s operating margins should remain strong or even improve.

Guidance

Returns on Investor Capital

Microsoft’s return on invested capital (ROIC) has shown strong growth over time. However, in recent years, it has slightly declined due to increased AI-related investments. Even so, Microsoft’s ROIC remains at an impressive 28.4%.

I also like to compare ROIC with the company’s weighted average cost of capital (WACC) to assess its efficiency in generating returns relative to its cost of funding.

Free Cash Flow

Free Cash Flow in 2025: For 2025, while Microsoft’s capital expenditures are projected to rise (due to AI investments), its free cash flow is expected to remain healthy, though growth could be slower in the short term. That said, analysts generally remain optimistic about Microsoft’s ability to generate robust FCF in the long run as AI and cloud services continue to scale.

Risks and Challenges

Intense Competition in Cloud and AI Markets

Cloud Computing: Microsoft’s cloud business, Azure, competes directly with Amazon Web Services (AWS), which is the market leader in cloud infrastructure. While Azure is growing quickly, it’s still chasing AWS in terms of market share. Additionally, Google Cloud and other smaller players are vying for the same enterprise customers, putting pressure on pricing and profitability.

Artificial Intelligence: Microsoft is making significant investments in AI, particularly through its partnership with OpenAI. However, it faces competition from companies like Google (with its AI-powered services) and Amazon (which has integrated AI in various areas of its business). These competitors could pose a threat to Microsoft’s growth in AI and cloud-based AI services.

Legacy Business Decline

Although Microsoft’s cloud and AI growth has been strong, it still has a large legacy business based on traditional software like Windows and Office. These products face increased competition from open-source software and alternative cloud-based solutions. A long-term decline in these traditional businesses could offset growth in Microsoft’s cloud and AI segments, slowing the company’s overall growth.

Valuation

After calculating Microsoft's discounted cash flow (DCF), I analyzed its weighted average cost of capital (WACC). Let me zoom in here so you can see it better—Microsoft's WACC stands at 9.3%. When compared to its return on invested capital (ROIC), which is more than three times higher, the ratio of ROIC to WACC exceeds 3:1. This is an excellent ratio for any company, especially one of Microsoft's scale.

This means Microsoft is generating returns well above its cost of capital, giving investors confidence in its ability to deploy capital efficiently. When a company like Microsoft invests $50 billion or even $80 billion, history suggests it will generate strong returns. Microsoft has consistently demonstrated its ability to allocate capital wisely, proving over decades that it knows how to invest effectively. When a company has a long track record of success in capital allocation, investors can feel confident in its ability to continue executing well.

Now, returning to valuation—this proprietary model I built estimates Microsoft’s intrinsic value at $447 per share, compared to its current market price of $387. Based on my DCF analysis, Microsoft appears undervalued.

Looking at other valuation metrics:

• Forward Price-to-Earnings (P/E) Ratio: 26 → Suggests undervaluation

• Price-to-Free-Cash-Flow (P/FCF) Ratio: 41 → Indicates fair valuation

So, out of the three valuation methods I used, two suggest Microsoft is undervalued, and one indicates it's fairly valued. I've always maintained that I’m willing to pay a fair price for an exceptional business—and Microsoft is certainly that.

Market sentiment

Growth Prospects in AI and Cloud Computing

Despite recent price declines, Microsoft has several key growth drivers that continue to generate optimism, particularly its cloud computing division and AI investments. With the company’s heavy involvement in artificial intelligence, including providing services to OpenAI's ChatGPT, many investors remain bullish on its long-term growth potential in these sectors. Microsoft’s cloud business is expected to continue thriving as more businesses transition to cloud-based solutions.

Investments in AI Infrastructure

Microsoft’s massive capital expenditures, particularly in AI infrastructure, have raised concerns over short-term profitability due to the heavy costs involved. However, investors are largely confident that these investments will pay off in the long run as AI adoption increases. Microsoft's track record of effective capital allocation and ability to generate strong returns on invested capital reassures investors that the company knows how to manage large-scale investments.

Strong Fundamentals Despite Market Fluctuations

Microsoft continues to show robust fundamentals, including double-digit revenue growth, a healthy operating profit margin, and impressive return on invested capital. These factors help mitigate concerns over the stock’s decline, as the company’s financial strength and scalability remain attractive.

External Market Factors

Market sentiment for Microsoft is also affected by broader economic conditions, such as interest rates, inflation, and overall stock market performance. In a rising interest rate environment, tech stocks, including Microsoft, may face additional pressure as higher rates could limit growth expectations and reduce the attractiveness of growth stocks.

Conclusion

While Microsoft’s stock price appears undervalued based on discounted cash flow (DCF) and price-to-earnings (P/E) metrics, the stock's valuation might not fully reflect the growth potential in cloud computing and AI. However, sentiment remains cautious due to the recent price drop, which has left some investors uncertain about whether the stock is truly a bargain or if it’s facing long-term challenges.

With 45% operating margins, a 3:1 ROIC-to-WACC ratio, double-digit revenue growth, and its leadership position in AI and cloud computing—Microsoft is operating at the heart of one of the fastest-growing industries today.

Given these factors, I believe Microsoft stock is still a buy with cautious.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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