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Why aren’t Microsoft shares rising after this latest monster news?

While some stocks rise and fall sharply during earnings season, other stocks remain steady. That’s pretty much it Microsoft (NASDAQ: MSFT) did, as the stock rose only slightly more than the broader market (as measured by the S&P500) the day after the win.

However, when you dig deeper into the quarter, you might wonder why the stock didn’t rise more, because it was truly incredible. If the price were to rise more, this could potentially be an opportunity to get in before other investors realize what they’ve been missing.

Microsoft crushed it during the third quarter

Microsoft has become a behemoth in its long rise to become the largest company in the world. Although it used to claim the title (besides Apple) of a $3 trillion company, it is no longer above that threshold. But with these results in mind, it could return there.

The law of large numbers states that the larger a number is, the closer it will be to the average population. When this is applied to companies and their growth rates, it means that giants like Microsoft are not allowed to grow faster than the average of all other companies in the market. But Microsoft challenges this assumption.

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In the third quarter (ended March 31), Microsoft’s revenue rose 17%, and earnings per share (EPS) rose 20% year over year. That’s much faster than most companies, making these results all the more impressive. In addition, all business segments exceeded second quarter expectations.

Business segment

Q3 annualized growth projection

Q3 YoY Actual growth

Productivity and business processes

9% to 10%

12%

Intelligent cloud

19% to 20%

21%

More personal computers

10% to 13%

17%

Data source: The Motley Fool and Microsoft. YOY = year after year.

But there’s one business segment that’s doing the heavy lifting. Of Microsoft’s three business groups, Intelligent Cloud was the outlier, with revenue increasing 21% year over year to $26.7 billion (35% of total revenue). This was made possible by Microsoft Azure’s incredible growth of 31% – the best of the three major cloud computing competitors. Why is cloud computing doing so well? It probably has to do with artificial intelligence (AI).

AI requires massive data storage and computing power to create the best models. Most companies can’t justify buying their own server to store and process this data, so they rent computing power from Microsoft. This is convenient for the customer because he or she can scale up or down usage as needed or rent more computing power if he or she needs to run a large model.

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As everyone rushes to implement AI in their businesses, Microsoft is seeing a huge increase in demand that is boosting Azure and other cloud services that Microsoft provides. Given how well Microsoft is doing, you’d think its stock prices would rise, but that’s not the case.

Microsoft stock was priced for perfection

There’s a good reason why Microsoft stock is still relatively flat after earnings. Heading into the quarter, Microsoft needed to post a perfect quarter to avoid a drop from its high levels.

MSFT PE ratio chart

MSFT PE ratio chart

Microsoft shares traded at nearly 39 times earnings less than a month ago, but are still trading at an expensive 35 times earnings after the results. That’s a premium price reserved for only a few companies that are growing quickly or performing at a high level. For reference: AI powerhouse Nvidia currently trades at 34 times forward earnings.

So to avoid a valuation drop, Microsoft had to post a perfect quarter, which essentially happened. Microsoft still has a premium valuation, so its Q4 execution should be flawless as well.

As a result, I don’t think this is a good time to buy Microsoft stock as there isn’t much room for upside potential. Instead, investors should shift their attention to other companies that offer similar levels of execution but trade at much lower premiums.

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*Stock Advisor returns May 6, 2024

Keithen Drury has no positions in the stocks mentioned. The Motley Fool holds positions in and recommends Microsoft. The Motley Fool recommends the following options: long January 2026 $395 calls to Microsoft and short January 2026 $405 calls to Microsoft. The Motley Fool has a disclosure policy.

Why aren’t Microsoft shares rising after this latest monster news? was originally published by The Motley Fool

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