Microsoft Stock: Buy or Sell? (My Final Verdict) | MSFT Stock Deep Dive Part 3

Microsoft provided a huge update about its capital expenditures that you're not going to want to miss. I'll start off in part three of this deep dive into Microsoft stock by talking about that big change. I'll also go on to share with you my updated fair value estimate and my updated buy, hold, or sell rating for Microsoft stock. Remember, coming into this quarterly financial update, I ranked Microsoft as one of the best stocks you could buy right now, so I was happy to see that the share price jumped following the financial update. >> I want to thank The Motley Fool for sponsoring this video. Visit fool.com/parkev for the 10 best stocks to buy now. >> So, here's the big change from Microsoft. "Effective the start of 2027, we are extending the estimated useful life of our data centers and the office buildings from 15 years to 25 years." So, they're extending the useful life of their data centers and office buildings from 15 to 25, adding 10 years of useful life, which the way it works on the financial statement is the depreciation expense will decrease over each individual year because it'll be spread out over more years. And I like that they described the difference here and how that's going to impact. They say, "The greater impact is on capital expenditures as more of their future data center leases will shift from finance leases to operating leases as a result of this update." Finance leases are included in capital expenditures, while operating leases are not. So, in other words, finance leases go into the capital expenditure number, which is on the cash flow statement, and then it eventually turns into it goes into the income statement through depreciation of the asset. Whereas operating leases don't go into the cash flow statement, they go directly into the income statement as an expense. And so that's the difference here that we're going to see going forward. And remember, the total spending on a data center, 1/3 of it is the building. 2/3 are the components that go inside the building. So this will impact roughly 1/3 of their data center spending going forward. Another thing they're forecasting is lower PC market demand in 2027 as higher component cost increase device pricing. We've already seen announcements from several major manufacturers that they will be raising prices on consumer electronic devices. They expect revenue to decline in the high teens for the fiscal year in this segment. So the higher memory prices as a result of the demand from data centers is impacting the PC industry and the smartphone industry for that matter. And Microsoft expects big declines here from their Windows OEM and devices segment due to this factor. Overall for 2027, they expect another year of double-digit revenue and operating income growth. And here's the big number everyone was looking at. They expect 2027 capital expenditures will grow year over year given the demand signals across our portfolio. So that's interesting, right? Um they just said grow. So other companies have said they expect their capital expenditures to grow significantly. Microsoft is just saying they expect it will grow. So [snorts] it'll be bigger than what they spent this year, which will be roughly $175 billion when it's all said and done. And so next year I'm estimating maybe $180, maybe $185 billion. And then, it looks like the year after that could be the year where they signal a flat or declining capital expenditure spending. Given that I think by the end of next year, we'll see a more equal supply and demand dynamic. Right now, there's still more demand than there is supply. By the end of next year, unless there's a new catalyst that drives demand even higher, I suspect that the industry will be in better balance. For the full fiscal year, they expect their operating profit margins to be flat, down less than one point, and they expect to remain free cash flow positive in the upcoming year. I don't think Amazon will be free cash flow positive in the upcoming year. Maybe not even Meta Platforms will be cash flow positive in the upcoming year. Alphabet will likely be cash flow positive, and then Microsoft cash flow positive. They're spending so much on capital expenditures, their cash flow from operations are not increasing by enough to keep pace with those big investment increases. So, adjusting for the impact from OpenAI, they expect healthy growth in commercial bookings. The significant OpenAI contract they signed in the prior year will result in some quarterly volatility in both bookings and RPO growth rates. So, reading between the lines here, seems like they're not going to add any contracts with OpenAI. They're not going to contract and agree to allocate computing power for OpenAI, given how much they've already allocated to them over several years, and given the questionable financial situation OpenAI finds itself in. Microsoft wants to diversify away from them. They don't want any more obligation to OpenAI, because if you look at from open AI's perspective, they want more computing power. They want all the computing power they can get. It helps them achieve better models, which helps them generate more revenue and more users, more engagement, but at the expense of bigger losses on the bottom line. Open AI wants to do it sooner rather than later. It expects that later on it'll grow so significantly, it'll have so much money it'll be able to pay back all of its obligations and then some, but their counterparties are growing increasingly nervous, including Microsoft. So, overall, it was a positive quarter for Microsoft moving in the right direction, adding significant amounts of engagement in its AI-enhanced features and products, investing in its own proprietary chips, getting better at building these data centers, getting faster at building these data centers from decision to completion, all of which is helping accelerate revenue and profitability and cash flow with Microsoft. And so, I'm not surprised to see the stock price jump as much as it did. So, it's now trading at a forward price-to-earnings ratio of 21, which I think is undervalued for Microsoft. So, I updated my discounted cash flow valuation for Microsoft, and I now value the business at $527 per share. And [snorts] the current market price after the increases following the earnings is now $493 per share. Applying a margin of safety, I can only say that Microsoft stock looks slightly undervalued when measuring on a discounted cash flow basis, but it does look undervalued when measuring on a forward price-to-earnings basis. Of course, Microsoft still faces the counterparty risk I mentioned earlier with open AI, and it's trailing in terms of large language models. It's developing its own large language models, but it's well behind. It doesn't have a model that it can rank up there among the leaders. And so that's going to be a bearish factor weighing on the company. However, the acceleration in cloud revenue in AI revenue is going to be a bullish factor in the company demonstrating an ability to do it even faster than they previously estimated. Will accelerate a lot of that backlog they have. Remember they have roughly $650 billion in backlogs, in customers that are waiting to purchase that computing capacity. So the faster they can get that online, the faster they can start generating that revenue. But for me, cloud revenue is a less exciting source of revenue. I'd like Microsoft to generate revenue from more of its sources that have stronger competitive advantages, from its productivity suite, from its Windows adoption increasing, from enhancing its various business services utilizing artificial intelligence. I'd like to see more acceleration from those segments, which I am starting to see in various degrees depending on the product that we're looking at. They have so many different products, business, consumer, etc. I'd like to see more of that. As a shareholder myself, that's talking from a shareholder perspective. So all that being said, after evaluating the results and updating my discounted cash flow model, I downgraded Microsoft stock. I formerly had Microsoft ranked as one of the top 12 stocks you can buy. I downgraded it to a buy from one of the best 12 stocks you can buy. The share price increase has been pretty significant. The stock was down almost 20% from February at one point and it's now up 16% since February. And I'm comparing to February because that's when I upgraded Microsoft to my list of top 12 stocks to buy. And since I upgraded to that list, the stock is up roughly 16%. And the business performance has been mixed. I've seen good and I've seen bad from Microsoft. Overall, I'm a shareholder. I own Microsoft stock. I'm not interested in selling my Microsoft stock. Um but I'm also less interested in buying at these levels.