It’s never been a good time to Microsoft(NASDAQ: MSFT) shareholder. Shares of the software and cloud computing giant fell, falling nearly 7% last week amid a broader market selloff. In the year to date, the technology stock is down more than 26% at the time of writing.
For investors looking at the company’s recent financial results, this drastic reduction may look like a great buying opportunity. In addition, Microsoft recently reported another outstanding quarter of top-line growth, driven by its impressive cloud performance.
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But the risks are increasing. Although Microsoft’s business is currently doing well, a closer look at the competitive landscape reveals that the rival Alphabet(NASDAQ: GOOG)(NASDAQ: GOOGL) it continues in the cloud. In addition, the rapid development of artificial intelligence (AI) presents new long-term risks to the software-as-a-service model that Microsoft relies heavily on.
So, is this a good time to buy the stock? Is it really a good time to avoid it?
Image source: Getty Images.
If you were to judge Microsoft solely on its second quarter financial performance, the stock sale would seem completely unnecessary.
During that period, which ended on December 31, Microsoft’s revenue rose 17% year over year to $81.3 billion. And the profits were even more impressive. Of the company non-GAAP (adjusted) earnings per share rose 24% to $4.14.
The main engine of growth, as usual, was the company’s cloud operations. Microsoft Cloud revenue increased 26% year over year to $51.5 billion. Of that total, “Azure and other cloud services” revenue, which represents the company’s cloud computing business, rose 39%.
Adding to the bull case, Microsoft’s remaining business operations liability (RPO) — a measure of contracted but not yet received revenue — increased 110% year over year to $625 billion.
On the surface, the business looks unstoppable.
However, the story changes when you zoom in and look at the broader cloud computing market.
Microsoft is investing heavily in capturing AI jobs, with capital spending rising 66% year over year to $37.5 billion in fiscal Q2. But despite this high spending, competition is increasing.
Consider the latest results from Alphabet. In the company’s latest quarter, Alphabet’s Google Cloud revenue grew at a staggering 48% year-on-year, reaching $17.7 billion. This far outpaced Azure’s 39% growth. In addition, Google Cloud’s growth rate has risen from 34% in the previous quarter and Microsoft’s “Azure and other cloud services” revenue has actually decreased. This cloud-computing revenue growth rate was 40% last quarter.
The fact that Google Cloud is growing faster than Microsoft’s cloud operations at such a critical time for investment in AI infrastructure shows that competition is intensifying in this new and important frontier. Microsoft’s cloud business may be bigger than Alphabet’s, but it appears to be losing some momentum to its rival.
Beyond the cloud computing battle, another strategic risk looms over Microsoft: the potential for AI to disrupt traditional software.
Microsoft’s manufacturing and business processes, which support its Office products, are very important to the company’s financial health. In fiscal Q2, this segment generated revenue of $34.1 billion. And Microsoft boasts more than 450 million business seats for Microsoft 365, making it heavily dependent on software subscriptions.
But as AI becomes more capable, the nature of software changes.
The rise of AI systems – software capable of planning and executing complex operations – could eventually reduce the number of workers needed for certain tasks. If businesses eventually need fewer human workers to perform basic knowledge work, they will naturally need fewer Microsoft 365 business seats. While AI tools like Microsoft’s Copilot offer near-term revenue opportunities, the long-term risk is that AI puts less pressure on the subscription model of each seat’s software.
And what’s more concerning is that AI enables more intense competition in general, which leads to lower cost power in software and ultimately lowers the network and — ultimately — the profits of software.
With Microsoft trading at around $357 per share as of this writing, the price-to-earnings ratio sits at around 22. Compared to the company’s historical highs, this may look like a good entry point.
But I believe the stock deserves to trade around its current value, or maybe even lower. The company is facing a brutal combination of rising capital costs, intensifying competition from Alphabet’s cloud – and unknown long-term risks that AI poses to its core subscription software business. Moreover, these unknown AI-generated risks may persist for years.
Overall, I think investors should consider sitting on the sidelines and waiting for a deep discount before buying shares. Given how fast Alphabet’s Google Cloud business is gaining market share and the unknowns generated by AI, it makes sense to wait for a price that represents a significant discount rather than paying what appears to be close to fair value. A broader security can help prices increase stock risks.
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Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions and recommends Alphabet and Microsoft. The Motley Fool has a publicity strategy.
Is Now a Good Time to Buy Microsoft Stock? was originally published by The Motley Fool
