1 flashing warning sign Microsoft investors must heed

this largest company in the world, Microsoft (NASDAQ:MSFT)which is also an expensive one with Trailing Price to Earnings Ratio 39. This could be a huge warning sign for investors.

So, what is this warning sign? What impact might Microsoft’s performance have on other markets? let’s see.

Microsoft stock has become expensive

The flashing warning sign for Microsoft stock is undoubtedly its valuation. The company trades at nearly 39 times earnings, making it the most expensive Microsoft stock since 2017 (except for a few years when its earnings were skewed by one-time events). Early 2000s.

MSFT P/E ratio chart

MSFT P/E ratio chart

There are two reasons why Microsoft has become so expensive: artificial intelligence (AI) and Microsoft’s ability to execute in this hot field. You have to give Microsoft the support it deserves; the AI ​​technology it’s rolling out is fantastic. Compared to many companies, Microsoft’s digital assistant is well integrated into its existing products and available for a reasonable fee (Copilot for Microsoft 365 is $30 per month with an annual commitment) .

It also has partners in OpenAI and its ChatGPT product, which many consider to be the best generative AI model, so Microsoft is well into the AI ​​game. In addition, its cloud computing business Microsoft Azure is growing faster than its cloud computing business Microsoft Azure. Top Competitors (30% annual growth in latest quarter, while Google Cloud grew 26% year-over-year and Google Cloud grew 13% year-over-year) Amazon Web services). This suggests that Azure could eventually surpass Amazon to become the top player in the space, which would bring a huge business boost.

Because Microsoft’s products have been performing well, the market has valued the stock at a premium. The problem is, if you shift your focus from tracking earnings to forward earnings forecasts, the stock doesn’t get much cheaper.

Microsoft’s premium valuation may not just be its own problem

Using the forward price-to-earnings ratio (P/E) is a better way to value a rapidly changing business. It uses analysts’ profit forecasts for the next 12 months to price stocks.

MSFT P/E ratio chartMSFT P/E ratio chart

MSFT P/E ratio chart

With Microsoft’s forward price-to-earnings ratio only slightly lower than its trailing price-to-earnings ratio, Wall Street analysts don’t think Microsoft will see much growth next year. for reference only, Nvidiaa company that has posted incredible growth numbers, trades at 38 times forward earnings and 80 times trailing earnings.

Microsoft needs to continue growing rapidly to keep investors happy. Wall Street analysts expect revenue to grow about 6% in the next quarter and 6.4% in fiscal 2024 as of June 30. They expect another 14% growth next year.

If Microsoft fails to meet investor expectations and its stock price declines, the broader market could be affected. Because Microsoft is so large, it accounts for about 7% of the entire market. S&P 500 IndexSo if Microsoft’s stock falls to cheaper levels (through falling prices, rather than increasing profits), the index will move heavily in the negative direction, which will negatively impact a lot of people’s accounts because many of them People own the S&P 500.

Furthermore, if Microsoft isn’t doing well, it’s probably because many other companies are struggling. Microsoft provides essential productivity tools to businesses around the world. If demand for its products starts to decline, that will be a sign that its customers (almost every business in the world) are starting to slow down their expansion. This could trigger a larger sell-off.

Regardless, if I were a Microsoft shareholder, I’d be a little concerned. The stock may be overvalued, but the impact of it becoming cheaper could hurt the larger market. Wall Street analysts don’t expect its 18% revenue growth to continue, although it’s difficult to predict the future of game-changing technologies like artificial intelligence. The market values ​​Microsoft as if it will have significant AI demand for some time, and any missteps could become a problem.

Microsoft may continue to do well, grow at market pace (or slightly above), but still be too expensive. With other stocks growing faster than Microsoft (such as Nvidia), there may be better places to deploy your money.

Microsoft could be a successful company, but given its valuation, the stock’s expectations are so high that it may be a difficult investment to make money over the next three to five years.

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Keith Drury There are no positions in any stocks mentioned. The Motley Fool holds a position in and recommends Microsoft. The Motley Fool recommends the following options: long the January 2026 $395 Microsoft call option and short the January 2026 $405 Microsoft call option. Motley Fool has disclosure policy.

1 flashing warning sign Microsoft investors must heed Originally published by The Motley Fool

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