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Wednesday, January 05, 2022 5:21:51 PM

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Microsoft's (MSFT) Growth Can Hide the Broad Market Slowdown
By: Simply Wall Street | January 5, 2022

Few companies have succeeded in revitalizing their brand, like Microsoft Corporation (NASDAQ: MSFT). Years ago, its brand perception was more aligned with established industrial stocks than IT growth companies. Yet, it delivered a multi-bagger performance, just in the last few years.

However, at this point, it is so big that it can hide a lot of weakness in the broad market.

One of the hottest keywords of 2021 was "metaverse." While the definition varies, Metaverse represents the next evolutionary step of the internet. A place where physical and digital become more intertwined, especially in the workplace that already got the digital tailwind during the COVID-19 pandemic.

Naturally, this represents a fresh growth opportunity for Microsoft, as Wedbush Securities believes they are on the way to a US$3tn market cap. While they acknowledge the impact of FED tightening, they also think that Wall Street underestimates Nasdaq by at least 12-15%.

Divergence in breadth

Whether in the bull market or the bear market, not every rise or decline is the same. The concept of market breadth looks at the number of advancing stocks vs. the declining stocks.

The following chart shows that Microsoft de-facto acted as a freight train of the broad market in 2021, leading the gains while also being one of the largest holdings of the S&P 500 index.

High concentration of S&P returns in Mega Cap Companies; Source: Goldman Sachs Global Investment Research

In this scenario, the leading companies can pull the indices to new highs even if the remaining majority shows stagnation, creating an illusion of the healthy market to anyone ready to scratch below the surface.

What is Microsoft worth?

According to our valuation model, the stock seems fairly valued at the moment. It's trading around 16% below our intrinsic value, which means if you buy Microsoft today, you'd be paying a reasonable price for it.

And if you believe the company's true value is $390.56, then there isn't much room for the share price to grow beyond what it's currently trading. What's more, Microsoft's share price may be more stable over time (relative to the market), as indicated by its low beta.

Can we expect growth from Microsoft?

NasdaqGS: MSFT Earnings and Revenue Growth January 5th, 2022

Future outlook is an important aspect when you're buying a stock, especially if you are an investor looking for growth in your portfolio. Although value investors would argue that it's the intrinsic value relative to the price that matters the most, a more compelling investment thesis would be high growth potential at a low price.

Microsoft's earnings over the next few years are expected to increase by 36%, indicating a highly optimistic future ahead. This should lead to more robust cash flows, feeding into a higher share value.

What this means for you:

Are you a shareholder? MSFT's optimistic future growth appears to have been factored into the current share price, with shares trading around their fair value. However, there are also other important factors that we haven't considered today, such as the company's financial strength. Have these factors changed since the last time you looked at the stock?

Are you a potential investor? If you've been keeping tabs on MSFT, now may not be the most advantageous time to buy, given it is trading around its fair value.

But, according to analysts, opportunities like Metaverse might not be fairly valued yet, and the positive outlook is encouraging for the company. It looks like it is worth further examining other factors such as the strength of its balance sheet to take advantage of the next price drop.

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