To The Moon

$Microsoft(MSFT)$

Microsoft is set to report its quarterly financial results after the markets close on January 29, 2025, sparking a lot of investor interest in whether they should buy Microsoft stock before earnings. In this video, I'll answer that question and preview what investors should be watching for in the upcoming earnings release. So, let’s take a closer look at this intriguing AI powerhouse.

Microsoft last updated investors on October 30, 2024, revealing a 16% increase in revenue to $65.6 billion. However, operating income only grew by 14% to $30.6 billion, which was a bit surprising. Typically, when Microsoft’s revenue rises by 16%, operating income sees a more significant boost due to the company’s strong operating leverage. Operating leverage means that as revenue grows, costs don't increase proportionally—costs tend to stay relatively flat. For example, if you think of Uber, where revenue and costs are closely tied (since they need to pay drivers for each ride), it’s a stark contrast to Microsoft, where costs don’t correlate as closely to revenue.

So, it was unexpected to see costs rise as much as they did alongside a 16% revenue increase. The main drivers of these higher costs have been investments in artificial intelligence and the acquisition of a gaming company, which Microsoft is still working to integrate. The process of digesting a new acquisition, finding synergies, and making staffing decisions can take time, but I expect Microsoft to show better leverage in the upcoming quarter.

Microsoft's CEO has highlighted that AI-driven transformation is reshaping workflows, business processes, and job roles across the board. The company is expanding its reach and attracting new customers as they help businesses harness AI to drive growth and improve efficiency. Virtually every business is looking to integrate AI in some way to either improve performance or reduce costs, so if you're not considering AI, you might be falling behind. Microsoft is playing a major role in helping enterprises improve their processes with AI.

One area where Microsoft is seeing growth is in its cloud business. Cloud revenue surged by 22%, totaling $39 billion, while the overall business grew by only 16%. This faster growth in the cloud segment is exactly what you want to see from Microsoft and other cloud-focused companies like Amazon, Alphabet, and others. The cloud space is lucrative—just look at Amazon’s cloud business, which generates operating margins around 30%. Microsoft is gaining ground here, though it still lags behind Amazon in the cloud market.

Another important factor I’ll be watching for is Windows OEM and device revenue. This segment generates income from licensing the Windows operating system to original equipment manufacturers (OEMs) and is closely tied to PC sales. In the latest quarter, this segment was relatively flat, up only 2%. Data from companies like Intel, Micron, and Taiwan Semiconductor, which also serve the personal computing sector, suggests the market isn't recovering as quickly as expected. So, these are some key things to keep an eye on when Microsoft reports its earnings.

For most of last year, I had been discussing the expected replacement cycle for personal computers. A lot of people bought PCs in 2020 and 2021, and now those devices are aging and in need of replacement. You can’t effectively use a 2020 computer for work unless you’re doing very light tasks like browsing the internet or answering emails. For more intensive work—like what I do—a 2020 PC just doesn’t cut it. However, the replacement cycle hasn’t materialized yet, and it’s getting delayed more and more. Most industry experts expected this cycle to begin in the second half of 2024, but that didn’t happen. Now, data from Taiwan Semiconductor and Micron suggests the cycle may be even slower than anticipated, potentially not starting until the second half of 2025. This is something I’ll be watching closely when evaluating Microsoft’s earnings.

This is a critical area for Microsoft because the Windows operating system serves as an entry point into its ecosystem. If you have Windows, you’re more likely to also subscribe to Microsoft Office or Microsoft 365. So, the success of this segment is important for driving growth in other areas of their business.

Microsoft is currently trading at a forward price-to-earnings ratio of 29.41, which is about average for the company over the past couple of years. It’s been more expensive and more affordable at different times, but right now it’s in the middle range. In recent months, I’ve called Microsoft fairly valued, and I also did a discounted cash flow model on January 1, 2025, which suggested an intrinsic value of around $447. The current market price is about $424, so I still consider it fairly valued—just $23 off a $400 stock. Given the variables involved, I consider this a reasonable price but lean slightly toward undervalued.

When evaluating top-tier companies with strong competitive advantages like Microsoft, I’m comfortable paying a fair price for a business of that caliber. Microsoft is exactly that: an excellent business at a fair price. That’s why I rate the stock as a buy, and I’ve updated my recommendation accordingly.

Now, to answer the question of whether you should buy before or after earnings: I don’t see a strong case for either option. When I’m in this situation, I usually recommend splitting your purchase—buy half before earnings and half after. If you’re more conservative and don’t mind missing out on a potential upside (say, a 5% or 10% increase), you can always wait and buy after earnings. So, I’d suggest either going with a split approach or waiting until after earnings, but I do like the stock overall. It’s fairly priced in, it’s an excellent business.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

@Daily_Discussion @TigerPM @TigerObserver @Tiger_comments @TigerClub