Some bubbles stimulate innovation – why Microsoft (NASDAQ: MSFT) may be underestimated

We looked at the U.S. technical sector and found that software and systems are still highly regarded in the marketplace. In this analysis, we start with market assessment, go by industry through the software industry and finally analyze Microsoft Corporation (NASDAQ: MSFT).

With this analysis, we want investors to get a better idea of ​​what is expected of the industry and compared to these stocks.

Here is a brief summary of our findings:

  • Without geopolitical escalation, the U.S. market could be close to fair value.
  • Bubbles can be found in areas with expected innovations that may not be as harmful.
  • Microsoft is slightly undervalued based on the P / E ratio, and is expected to maintain innovation growth.

Market valuation

Starting from the top down, we see that in the US market the current average P / E is 16.8x, which is close to the 10-year average of 17.7x. On a relative basis, it seems that the market is close to fair value. However, current profits are $ 1.9 t and projected annual revenue growth is 13%. We can use these metrics to get intrinsic value for the market: current profit * (1+ future growth) / Premium for enterprise risk = market value

Calculation: 1.9 t x 1.13 ÷ 0.0475 = 45.2 t

Based on this, the US market seems to be overvalued by 10.5%. within error. Keep in mind that if any of these estimates change in the future, so will the estimate.

Also, this approach should not be used with markets that expect long future growth periods (e.g., emerging markets) – what we are essentially doing is assuming that the U.S. will maintain projected revenue levels and not grow much higher.

US Market Valuation, April 7, 2022

You’ll notice in the chart above that the market capitalization seems to indicate what some would call a “bubble”. While this is true, here’s what to keep in mind: in 2021, the market was filling up with what was lost in 2021, so you can see a jump in profits. With the exception of large-scale geopolitical deterioration, 2022 is likely to lead to the normalization of these revenues, and the market may adjust.

Now there is another important factor for high market capitalization – speculation in the technology industry (as you will see below). It can be argued that the market is funding new ideas that involve high growth, which, in truth, may not be realized. However, bubbles are a feature, not necessarily a bug in the systembecause they allow us to innovate with extra capital, and for a healthy economy we may want to feel comfortable with some degree of “bubble” as they can lead to high growth in the future.

Continuing down the branch, we reach the technical sector and the software industry.

Software industry evaluation

The market capitalization of the industry has over the last 3 years has grown by about 96% and profits have grown by 30%. This means that the market is ahead of profits and expects the industry to top its significant future growth.

Analysts also expect the industry to continue to grow and fprojected revenue growth of 16.5%.with an increase of 21.5% in the Application subcategory.

We also see that the P / E of both general and application software is about 34x, while the subcategory of systems has a P / E of 54.6x. That probably means that the system industry is most prone to correctiongiven the low projected growth and high difference from the 3-year average P / E of 32x. For this reason, we will focus on software stocks for applications as they can deliver high growth and are closer to historical P / E averages.

evaluation software
U.S. Software Sector Assessment, April 7, 2022

If you want to find stocks in the software industry, you can check out our review in the Markets section.

One of the stocks that have lost some of their market capitalization but have a strong foundation in the industry Microsoft Corporation (NASDAQ: MSFT), this is something we will evaluate next.

Microsoft’s relative assessment

With a price-to-earnings ratio (or “P / E”) of 31.5 times, Microsoft seems to be trading on the line if not slightly below the software industry average.

The company has a high return on net income of 38% and a return on capital employed of 30% (compared to 18.7% 3 years ago). It is not surprising why investors are delighted with this stock and are one of the hallmarks of the market. For investors, much of Microsoft’s profits come from rising stock prices, although shares also have a modest 0.83% dividend.

See our latest analysis for Microsoft

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Price NasdaqGS: MSFT based on past earnings April 7, 2022

As we noted earlier, high P / E implies anticipation of future growth and innovation. So we need to compare company prices with future growth expectations.

Looking to the future, earnings per share are expected to grow 14% year-over-year over the next three years, according to analysts observing the company, and earnings are also expected to grow slightly higher, 12.5% ​​year-over-year.

Big profits, high margins and positioning in an area where innovation is still possible make Microsoft a solid stock for investors.

Next steps:

To better understand before making a decision, there are a few more important things to consider:

Simply Wall St analyst Goran Damczewski and Simply Wall St do not hold positions in any of these companies. This article is general. We provide comments based on historical data and analysts ’forecasts, using only unbiased methodology, and our articles are not intended as financial advice. This is not a recommendation to buy or sell any stocks and does not take into account your goals or your financial situation. We aim to provide you with long-term focused analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company ads or quality materials.

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