Key insights
- A DCF analysis suggests Microsoft is fairly valued, with a base case of $422.15 versus a current price of $370.87. The model highlights that 66.9% of the valuation relies on terminal value assumptions. Near-term profitability is pressured by AI infrastructure spending and the uncertain monetization timeline. A significant portion of commercial RPO is tied to OpenAI, adding to the uncertainty. The analyst concludes MSFT is a great company, but not currently undervalued.
I ran my DCF model on Microsoft and came to a conclusion that's pretty uninspiring.
The company is excellent, the valuation "bargain" everyone talks about is mediocre, at best.
My base case is $422.15/share versus a market price of $370.87 (Friday's April 10 close), which implies about 13.8% upside and only a 12.2% margin of safety.
In my framework, that is not enough to call the stock truly undervalued.
My model is not aggressive in my opinion, but it's not pessimistic either. I assume 15% revenue growth in FY2027, then a gradual deceleration to 4% by FY2036.
I use a 46% EBIT margin next year, expanding to 48% by Year 10, a 20% tax rate, cash capex at 25% of revenue in FY2027 falling to 10% by FY2036.
this results in 8.9% WACC, and I use 3.0% terminal growth.
On those assumptions, I get about $1.045T in present value from the 10-year cash flows and $2.115T from terminal value, for a total enterprise value of $3.16T.
After the equity value bridge, that comes to roughly $3.149T equity value, or $422.15/share.
One thing I think value investors should pay attention to is that 66.9% of the valuation comes from terminal value.
My scenarios are:
$310 bear case,
$422 base case,
$578 bull case.
The bear case assumes 9.9% WACC, 2.5% perpetual growth, and margins drifting down from 45% to 44%. The bull case assumes 7.9% WACC, 3.5% perpetual growth, and margins expanding from 46.5% to 49%.
The core issue imo is that Microsoft is still in a very capital-heavy AI buildout. The business quality is undeniable, but near-term economics are being pressured by infrastructure spending, depreciation, and uncertain timing of AI monetisation. Even the $625B commercial RPO needs context which is often omitted from what I've seen around. About 45% of it is tied to the world champion of burning cash - OpenAI, and only roughly 25% is expected to be recognised over the next 12 months...
So my conclusion is that Microsoft is a wonderful business trading around fair value.
I can justify owning it (and I do own it since 2017) and even buying it as a truly world-class business with mild discount to its fair value. I have a much harder time justifying calling it a clear value play at today’s price, or tag it convincingly "undervalued".
For me, it starts to look more interesting below $358, and I would be loading the boat around $335.
For those interested, here's the article with full valuation model for free: https://open.substack.com/pub/hatedmoats/p/microsoft-dcf-valuation
Curious how you guys here would underwrite / approach the capex cycle and terminal assumptions, and what your thoughts on current fair value of MSFT are!