This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Key Points
- Microsoft crushed the S&P 500 over the past decade.
- Its growth was driven by its “mobile first, cloud first” mantra.
- Its stock isn’t cheap, but it still has a lot of upside potential.
When Satya Nadella succeeded Steve Ballmer as Microsoft's (NASDAQ: MSFT) CEO on Feb. 4, 2014, many investors dismissed the tech giant as a slow-growth stalwart with limited upside potential. But if you had invested $10,000 in Microsoft on Nadella's first day on the job, your investment would be worth $140,000 today and paying out nearly $1,000 in annual dividends.
That same investment in an S&P 500 index fund would only be worth about $38,000 today. Let's see why Microsoft crushed the market -- and if it's still a good stock to buy.
How did Microsoft become a growth stock again?
Under Ballmer, Microsoft struggled to keep pace with Amazon (NASDAQ: AMZN), Alphabet's Google (NASDAQ: GOOG) (NASDAQ: GOOGL), and Apple (NASDAQ: AAPL) in the mobile and cloud markets. Its Windows and Office products still relied on periodic desktop upgrades, and its Windows Phones couldn't keep up with iPhones and Androids.
But after Nadella took over, Microsoft adopted an ambitious "mobile first, cloud first" strategy. It transformed its Office desktop software into cloud-based services, expanded its Azure cloud infrastructure platform, and integrated those upgrades into Windows. It also scrapped its Windows Phone program, launched iOS and Android versions of its top productivity apps, rolled out more Surface devices, and expanded its Xbox business with new products and bold acquisitions.
Microsoft launched more AI services to process all the data that flowed through that sprawling ecosystem. It also started to accumulate a big stake in OpenAI -- the creator of ChatGPT and other generative AI applications -- in 2019. It then integrated OpenAI's tools into its Bing search engine, Azure's cloud platform, and its Copilot AI services.
Microsoft's aggressive investments in the mobile, cloud, and AI markets initially squeezed its margins. But from fiscal 2015 to fiscal 2025 (which ended this June), its revenue grew at a compound annual growth rate (CAGR) of 12%, its gross margin expanded from 64.7% to 68.8%, and its earnings per share (EPS) increased at a CAGR of 5%. It maintained that momentum even as the pandemic, inflation, rising interest rates, and geopolitical conflicts rattled the global economy.
Most of Microsoft's recent growth was driven by its cloud-based services. Azure is now the world's second-largest cloud infrastructure platform after Amazon Web Services (AWS), and its Office suite -- which was rebranded as Microsoft 365 in 2020 -- holds a near-duopoly in the productivity software market with Google Workspace.
Why will Microsoft keep growing?
From fiscal 2025 to fiscal 2028, analysts expect Microsoft's revenue and EPS to increase at CAGRs of 15% and 16%, respectively. That robust growth should be driven by the secular expansion of the cloud and AI markets. More companies should migrate their data to its public cloud, hybrid cloud, and edge deployments, while the expansion of its data centers should support the development of even more powerful AI applications across its ecosystem.
Microsoft still faces intense competition from Amazon and Google in the cloud and AI markets, but it will likely draw in big companies that compete against those two tech giants in the e-commerce, streaming media, and digital advertising markets. Its Xbox gaming business, which absorbed Activision Blizzard and many other top game publishers, could also generate more recurring revenues with its Game Pass and Cloud Gaming services. The company also still held $94.6 billion in cash, cash equivalents, and short-term investments at the end of fiscal 2025. That gives it plenty of room to expand its business via more acquisitions or buy back more shares to boost its EPS.
Is it the right time to buy Microsoft's stock?
Microsoft's stock doesn't look cheap at 33 times this year's earnings, but the robust growth of its cloud and AI businesses might justify that higher valuation. Even if it trades at a more modest 30 times forward earnings and it merely matches analysts' expectations through fiscal 2028, its stock could still rise about 26% to $645 over the next two years.
That return might not dazzle growth-oriented investors, but it would likely keep Microsoft's stock ahead of the S&P 500, which has generated an average annual return of 10% ever since its inception. Therefore, I think it's still a great stock for long-term investors to buy, hold, and forget.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
