What happened
It’s the second trading day of the new year, and with the Nasdaq Composite index rising more than 1% in early afternoon trading, it looks like things are off to a good start for tech stocks.
For most tech stocks, that is. Microsoft (MSFT -5.45%) however, is missing out on the rally. The stock had slumped by 4.8% as of 2:20 p.m. ET, and investors can blame UBS in part for that.
So what
Bright and early Wednesday morning, UBS analyst Karl Keirstead downgraded Microsoft stock from buy to neutral — and cut the bank’s price target on the tech company by 17% for good measure, says StreetInsider.com.
Predicting that Microsoft will enjoy only “moderate” growth in licenses for Microsoft Office in 2023 and a “steep growth deceleration” in revenue from Azure cloud services, Keirstead warns of falling gross margins ahead for the company. Revenue growth is likely to slow as well. As a result, he expects that Microsoft stock will probably end this year at around $250 a share — only $10 higher than where it started the year. And in the analyst’s opinion, the potential for 4% share price growth (even with a dividend that yields 1.1% at the current share price) simply doesn’t deserve a buy rating anymore.
Now what
It’s hard to say which of these UBS predictions should worry Microsoft investors more.
“Productivity and business processes,” the Microsoft division that contains its Office suite of products, is the company’s most profitable business by margin. It generated a 47% operating profit margin last year, according to data from S&P Global Market Intelligence. On the other hand, “intelligent cloud” — the division that Azure calls home — is the company’s most profitable division, period, churning out $32.7 billion in operating profits last year. It’s also Microsoft’s biggest revenue driver, with 2022 revenue of more than $75 billion. Intelligent cloud is also the major driver of Microsoft’s revenue growth, having nearly tripled in size over the past five years, while productivity and business processes only just doubled.
Ultimately, though, a slowdown in either of these two marquee divisions spells bad news for the stock. It’s trading at more than 25.5 times earnings and more than 28 times free cash flow, and most analysts forecast that Microsoft’s earnings will grow by only about 12% annually or so over the next five years. Now UBS seems to be suggesting that even 12% might be a stretch.
Even after losing 24% of its market capitalization in 2022, Microsoft still might have farther to fall.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft. The Motley Fool has a disclosure policy.
