Microsoft’s bullish signal suggests a rise in its stock price

Microsoft NASDAQ:MSFT stocks entered a correction ahead of the third-quarter earnings release, setting it up for a trend signal that is now in play. The third quarter results reveal a classic supply-demand imbalance underlying the results, leading to outperformance and pushing the market higher. The imbalance favors Microsoft and is centered on artificial intelligence. The company has increased CAPEX spending, including AI infrastructure, by 79% over the past year, but has yet to meet demand. This fact offsets plans to increase CAPEX again, leading to increased revenues and sustained growth over the next twelve to eighteen months.

Analysts rejoice at the news. The first dozen widespread revisions include twelve price target increases that caused the consensus, up 35% year-over-year and 7.5% over the past 30 days, to move higher. The consensus implies a 9% upside from the pre-release price, but the new range is much better. The new range implies a 16.5% upside at the low end.

Aside from the strength of AI, the main point is that established, blue-chip and leading technology companies have the lion’s share of AI and will dominate the industry as it advances. Reminiscent of the company’s developer conference earlier this year, the release was a name-dropping event, underscoring the importance of NVIDIA NASDAQ:NVDA AND Advanced microdevices NASDAQ:AMD accelerators, Oracle NYSE: ORCL AND LYMPH New York Stock Exchange: SAP database workloads and the importance of Microsoft as the go-to source for infrastructure and services by large enterprises such as The Coca-Cola company NYSE: KO.

Microsoft has a solid quarter, elevator guidance

Microsoft reported a stellar quarter with net revenue of $61.9 billion, up 17.1% year over year and beating consensus estimates by 160 basis points. Exceeding 160 basis points is not material, other than the fact that analysts have raised their estimates over the past year. The growth was driven by a 21% increase in Intelligent Computing, a 17% increase in More Personal Computing and a 12% increase in Business Products and Processes. When it comes to cloud and AI, Microsoft Cloud grew 23%, while Azure led with 31%.

Margin news is also favorable. The company expanded its gross and operating margins thanks to sales growth, increased leverage and spending discipline. Operating margin was expanded by 200 basis points to leave GAAP earnings at $2.94, or up $0.11 from last year and $0.11 better than expected. GAAP earnings have grown more slowly than revenues due to increased CAPEX spending, which drives growth and leads to higher free cash flow and cash flow. Free cash flow grew 31% and is expected to remain strong through year-end and into the next fiscal year.

The forecasts are mixed, but reveal that the market expected the worst. As it stands, the company expects fourth-quarter revenue to be in a range just below consensus, but the full-year tally is above average due to the strength of the third quarter. As the company shows momentum and is investing heavily to meet demand, it is likely to beat today’s estimates in the coming quarters to eighteen months.

Microsoft’s valuation is not a pressing concern

Microsoft is among the most popular blue-chip tech stocks today, but that’s no cause for concern. The P/E multiple of 35X is not a cause for concern because this company is holding out hope in AI. It is growing, sees strong demand and is working hard to meet it. Estimates for the next fiscal year bring the valuation down to a more reasonable 29X, and the estimates are likely conservative.

The technical action is favorable. The market is up over 3% following the news and confirmation of support at the 150 day EMA. The bounce from the EMA is a trend following signal and will likely result in a move towards $440 or above. $440 aligns with the current consensus target, a target foreshadowed by previous price action, and is the indicated minimum move. As analysts are taking the market towards the $500 region, a 20% to 25% upside is still possible.

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