“Microsoft is back to showing durable double-digit EPS growth — and investors should be willing to pay a higher multiple for that growth,” said Weiss in a note.
The analyst presented three arguments for why investors should have faith in the company’s upward trajectory (see Weiss‘ track record).
Outperforming The Market
The company is trading at a premium of 16 percent to the S&P 500, in line with the past two years. That said, it’s total return profiles has a premium of about 50 percent.
Thinking Of The Whole
Weiss previously estimated that Microsoft’s cloud business is worth $250 billion, valuing the rest of the company at 7x EV/FCF. But when updated for the increase in stock price to $70 and using the calendar 2018 free cash flow numbers, that valuation rises to 8x EV/CY18 FCF.
The non-cloud portions of the company — Xbox, Bing, Surface, etc. — are slow growing, but have proven more durable than investors feared. They could lead to a 12x multiple, adding $115 billion in enterprise value.
The cloud business itself could also add up to $30 billion in enterprise value through greater adoption of Azure and increased monetization from O365 and machine learning.
Focus on Free Cash Flow
Of the software companies Morgan Stanley covers, only Microsoft reports a GAAP EPS number. This led second-quarter results to appear muted.
Looking at free cash flow though, the company is better positioned than many of its software and large-cap peers.
As ASC 606 becomes standard across the industry, and earnings become less comparable, investors should begin to look toward EV/FCF multiples with more weight.