Gates Dispensed Additional Microsoft Shares in Q3; Should Investors Purchase, Sell, or Hold?
Gates Dispensed Additional Microsoft Shares in Q3; Should Investors Purchase, Sell, or Hold?
The swift embrace of synthetic intelligence (SI) has been fantastic for Microsoft (MSFT -0.67%). The stock has surged 72% since 2022, yet this might cause some investors to question if it's still a wise investment. After all, the stock's price-to-earnings (P/E) ratio currently stands at 34, which is near the higher end of its 10-year range and higher than the S&P 500's P/E of 30.
Bill Gates, the co-founder and former CEO, has transferred billions of Microsoft shares to the Bill & Melinda Gates Foundation. Despite the foundation maintaining a substantial stake in Microsoft, it has offloaded shares in each of the last four quarters.
Remember, the Gates Foundation has been voluntarily divesting from Microsoft shares for years, reflecting its charitable goals for the assets. Notably, other prominent investors such as Chase Coleman's Tiger Global Management and John Armitage's Egerton Capital continue to hold substantial stakes in Microsoft.
Microsoft is currently experiencing a wave of success, which might tempt investors to follow these billionaires into the stock. However, paying a high P/E for the shares may be challenging considering the effect of Microsoft's SI investments on its earnings growth. The Gates Foundation's recent transactions may hint at lower anticipated returns for the stock, which could serve as a caution to investors.
SI is driving robust revenue expansion
From a revenue standpoint, Microsoft's performance is as excellent as an investor could hope for. Microsoft cloud revenue grew 22% year over year in the first quarter, reaching $39 billion. Demand for Azure cloud services remains robust. Even Microsoft's personal computing business, including the Xbox gaming segment, has witnessed a significant surge following the acquisition of Activision Blizzard.
Despite the stock's high P/E, one reason investors might choose to maintain their position is Microsoft's financial resilience. Companies with consistently rising free cash flows have a knack for surpassing expectations. Microsoft's high-margin business generated a stunning $72 billion in free cash flow over the previous year. In the past quarter alone, it dispensed $9 billion back to shareholders through dividends and share buybacks.
It's returning cash to shareholders while investing heavily in SI infrastructure. Microsoft has already embedded SI services across its software offerings. SI services contributed 12 percentage points to Azure's 33% year-over-year revenue increase last quarter. The company seems well-prepared to monetize SI and drive revenue growth in the long term.
However, Microsoft's growth is exacting a price
Microsoft is benefiting from strong demand for SI services, but investors should be aware of the lack of progress on the income side. While the company's total revenue grew 16% year over year last quarter, investments in SI constrained free cash flow, which declined 7% compared to the year-ago quarter. This is probably transient, but the impact of these investments on free cash flow in the short term could impact the stock's performance.
Returning to the Gates Foundation's transactions, it's worth noting that the timing of these transactions in recent years has corresponded with the stock's value. When the stock was cheaper, the Foundation refrained from selling shares, acknowledging the stock's value and return prospects.
Analysts expect Microsoft's earnings to escalate by almost 11% in fiscal 2025 (which concludes in June). That isn't enough growth to justify the stock's high P/E multiple, especially considering that other Magnificent Seven stocks are trading at lower valuations and offering better earnings growth prospects, such as Meta Platforms and Alphabet.
For an investor already holding shares, I wouldn't sell and incur capital gains taxes just because the stock is temporarily expensive. Microsoft is a fantastic company worth keeping, but for an investor allocating fresh capital to the stock market, I would ponder other alternatives first.
In the context ofMicrosoft's financial strategy, the Gates Foundation's decision to sell shares might indicate a perception of lower anticipated returns, serve as a caution to other investors. Despite the robust revenue growth driven by SI services, the high P/E ratio and the impact of SI investments on free cash flow might make some investors pause before investing or increasing their positions in Microsoft.
When discussing investing in Microsoft, one could argue that despite the stock's high P/E, its financial resilience and high-margin business generating substantial free cash flow could make it an attractive option for investors who believe in the company's long-term potential and its ability to monetize SI services.