Microsoft MSFT may very well be one of those stocks to buy and hold forever. Known for its Windows operating system and Office productivity suite, Microsoft continues to widen its economic moat with a broad portfolio that now spans productivity and business processes, intelligent cloud, and personal computing. Today, its moat has not just one but three sources (cost advantage, network effect, and switching costs), which is more than many wide-moat companies can say. Management has done an outstanding job of allocating capital, and we have confidence in CEO Satya Nadella’s strategic vision to carry Microsoft forward. The best news for investors: The stock is a buy, trading 21% below our $490 fair value estimate.

Microsoft is now a more focused company that offers impressive revenue growth with high and expanding margins and deepening ties with customers. We believe that Azure is the centerpiece of the new Microsoft. Even though we estimate it is already an approximately $75 billion business, it grew at an impressive 30% rate in fiscal 2024. Microsoft is also shifting its traditional on-premises products to become cloud-based solutions. Critical applications include LinkedIn, Office 365, Dynamics 365, and the Power Platform, with these moves now beyond the halfway point and no longer a financial drag. The company is pushing its gaming business increasingly toward recurring revenue and residing in the cloud as well. Thanks to its investment in OpenAI, Microsoft has also emerged as a leader in artificial intelligence.

Key Morningstar metrics for Microsoft

  • Fair Value Estimate: $490
  • Star Rating: 4 Stars
  • Economic Moat Rating: Wide
  • Uncertainty Rating: Medium

Economic Moat rating

For Microsoft overall, we assign a wide economic moat, arising primarily from switching costs, with network effects and cost advantages as secondary moat sources. We believe the productivity and business processes segment and intelligent cloud segment have earned wide moats, and the more personal computing unit warrants a narrow moat. We believe Microsoft is likely to earn returns in excess of its cost of capital over the next 20 years. The more critical the function and the more touch points across an organization a software vendor has, the higher the switching costs. There is also the direct time and expense of implementing a new software package for the customer while maintaining the existing platform and retraining employees on a new system. Additionally, there is operational risk in changing software vendors.

Fair Value estimate for Microsoft

Our $490 fair value estimate implies a fiscal 2025 enterprise value/sales multiple of 13 times and an adjusted price/earnings multiple of 38 times. We model a five-year revenue compound annual growth rate of approximately 13% including the Activision acquisition. We envision stronger revenue growth ahead as Microsoft had been bogged down by the 2008 downturn, the disposal of the Nokia handset business, and the onset of the model transition to subscriptions. However, we believe macro and currency factors will pressure revenue in the near term. We model operating margin increasing from 45% in fiscal 2024 to 46% in fiscal 2029, driven by improvements in gross margin as Azure continues to scale as well as some operating leverage. We expect some interim pressure on gross and operating margin in fiscal 2025 from an accounting change, Activision pressure, and investment in Azure capacity.

Risk and Uncertainty

Microsoft’s high market share in client-server architecture over the last 30 years means that significant high-margin revenue is at risk. The company must continue to drive revenue growth of cloud-based products faster than revenue declines in on-premises products. Microsoft is acquisitive, and while many small deals fly under the radar, it has had several high-profile flops, including Nokia and aQuantive. The public cloud buildout is in its early phases. Amazon Web Services has taken the market by storm, with Azure trailing. In this rapidly evolving market, Microsoft must continually adjust its offerings and compete with a company that has built a business around aggressive pricing.

Microsoft bulls say

  • Public cloud is widely considered to be the future of enterprise computing. Azure is a leading service that benefits from the evolution first to hybrid environments and then to public cloud environments.
  • Microsoft 365 benefits from upselling into higher-priced products as customers are willing to pay up for better security and Teams Phone; this should continue over the next several years.
  • Microsoft has monopoly-like positions in various areas (Windows, Office) that serve as cash cows to help drive Azure growth.

Microsoft bears say

  • The ongoing shift to subscriptions in slowing, particularly in Office, which is generally considered a mature product.
  • Microsoft lacks a meaningful mobile presence.
  • Microsoft is not the top player in its key sources of growth, notably Azure and Dynamics 365.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.