Is Microsoft's Stock Overvalued Or Undervalued?

Microsoft Corporation MSFT shares have outperformed the S&P 500 in 2021, generating a year-to-date total return of 33.1%.

Microsoft is still putting up impressive growth numbers. But with a $2.25 trillion market cap, some investors are wondering if there’s any value left in Microsoft stock.

Earnings: A price-to-earnings ratio (PE) is one of the most basic fundamental metrics for gauging a stock’s value. The lower the PE, the higher the value. For comparison, the S&P 500’s PE is currently at about 34.6, more than double its long-term average of 15.9.

Microsoft’s PE is currently 36.5. While that number is certainly under the S&P 500 average as a whole, Microsoft’s PE is up 35% over the past five years, suggesting its earnings multiple is on the high end of its historical range.

Related Link: Is Apple's Stock Overvalued Or Undervalued?

Growth: Looking ahead to the next four quarters, the S&P 500’s forward PE ratio looks much more reasonable at just 20.7. Unfortunately, Microsoft’s forward earnings ratio of 29.1 doesn’t make the stock undervalued at its current price. In fact, it appears to be slightly overvalued compared to technology sector peers that are currently averaging a 26.4 forward earnings multiple.

However, when it comes to evaluating a stock, earnings aren't everything.

Growth rate is also critical for companies that are rapidly building their bottom lines. The price-to-earnings-to-growth ratio (PEG) is a good way to incorporate growth rates into the evaluation process. The S&P 500’s overall PEG is currently about 1; Microsoft’s PEG is 2.4, a potential red flag that the stock has become overheated.

Price-to-sales ratio is another important valuation metric, particularly for unprofitable companies and growth stocks. The S&P 500’s PS ratio is currently 3.1, nearly twice its long-term average of 1.62. Microsoft’s PS ratio is 13.3, definitely not what a value investor is looking for.

Finally, Wall Street analysts see modest gains for Microsoft shares over the next 12 months. The average analyst price target among the 33 analysts covering Microsoft is $330, suggesting about 11.5% upside from current levels.

The Verdict: At its current valuation, Microsoft stock is showing a couple of warning signs of being overvalued, so investors should proceed with caution.