Microsoft Stock May Have Peaked, But It's Still On Track for Solid Growth

Microsoft (MSFT) stock reached its 5-year peak recently and hit a price of $335.40 on June 2, near its 2021 peak of $343.11 on Nov. 19, 2021. However, MSFT stock may slip a bit from here, as investors try to decide whether the US is going to enter a recession. 

Nevertheless, Microsoft is still on track for solid free cash flow (FCF) growth over the next year. As a result, this makes MSFT stock a good play for long-term investors.

Solid FCF Growth

I discussed this play and Microsoft's solid FCF in my last article a month ago on May 10, “Unusual Call Option Activity in Microsoft Indicates a Bullish Outlook On MSFT Stock.” For example, based on the company's April 25 earnings release and earnings call slides for its Q3 fiscal quarter ending March 31, the company's FCF was $17.8 billion. 

Although this was down 11% year-over-year, it was really only 5% lower at $19 billion on an adjusted basis, after excluding a one-time tax effect. More importantly from a forecasting perspective, its FCF margin was 35.9% based on $52.9 billion in revenue.

In other words, well over a third of its revenue, almost 36% goes straight to the bottom line, based on its superior cash flow profitability. We can use that to come up with a price target for MSFT stock.

Using FCF Margins to Estimate Its Value

One way to do this is the use analysts' estimates for forecasted revenue and apply an FCF margin, and then use a reasonable multiple for the stock. For example, analysts surveyed by Seeking Alpha estimate revenue for the year ending June 30, 2024, could reach $235.74 billion. 

That is up 11.5% from their estimates of $211.38 billion for the year ending June 30, 2023. If we assume that FCF margins will stay at 36% then, its free cash flow could hit $84.9 billion (i.e., 0.36x $211.38 billion) in 2024. 

This is a massive amount of FCF, especially since for the year ending June 30, 2022, Microsoft generated just $65.1 billion in free cash flow. And for the year ending June 30, 2023, using a 36% margin, FCF could be $76.1 billion (i.e., 0.36x $211.38 billion).

As a result, we can say that the market will highly value the company's consistent FCF margins and growth. For example, right now, MSFT stock has a market cap of $2,480 billion (i.e., $2.48 trillion). This is 32.6x its June 30, fiscal year FCF estimates.

Setting a Price Target for MSFT Stock

Since the market always looks forward, we can estimate that in 3 to 6 months, the market will expect FCF will reach $84.9 billion (see above). Using a multiple of 33x, this pushes its market cap estimate in the future to $2.8 trillion. That is 13% higher than its present $2.48 trillion market cap.

But that is not the final calculation if we want to estimate a per-share price target. This is because Microsoft is buying back its shares at the rate of at least $4.6 billion a quarter. That is an annual rate of $18.4 billion, which represents 0.74% of its $2.48 trillion market value. That means that we can add that percentage to the 13% expected price target growth.

Here is the final result. MSFT stock is worth at least 13.74% more than its price today of $323.84 per share. That puts its price target at $368.34, which will be an all-time high. 

That is why despite the stock's short-term weakness, long-term investors should take a patient view based on its powerful FCF.

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