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Microsoft Goes From Strength to Strength, Based on Its Powerful Free Cash Flow

InvestorPlace - Stock Market News, Stock Advice & Trading TipsMSFT stock could move 40% higher to $420 based on its powerful free cash flow generation and even higher if...

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This story originally appeared on InvestorPlace

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

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Microsoft (NASDAQ:MSFT) produced a stellar four quarter earnings report on Jan. 25. It is clearly indicative of an ability to produce large amounts of free cash flow (FCF). This is what I wrote on Jan. 31 in my latest article on MSFT stock.

Image of corporate building with Microsoft (MSFT) logo above the entrance.
Source: NYCStock / Shutterstock.com

This could push the stock significantly higher over the rest of this year, despite the turbulence in the market. In fact, the stock has held up fairly well over the past month as the market has cratered.

For example, as of March 2, MSFT stock closed at $300.19. This is just 10.7% below where it closed on Dec. 31 at $336.32. By comparison, the S&P 500 Index (GSPC) is down 8% year-to-date. So, even though tech stocks have taken a huge hit year-to-date (YTD), Microsoft is down only slightly worse.

On the other hand, however, both Apple (NASDAQ:AAPL) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) have done slightly better than the market. AAPL stock is down just 6.2% YTD and GOOG stock is off just 6.86% YTD, as of March 2.

Nevertheless, I think this difference is more or less irrelevant in the short term. Long-term MSFT stock has the potential to follow the fundamentals of its powerful FCF.

Where Things Stand at Microsoft

The conclusion that I reach at the end of January still stands. I wrote:

…based on analyst projections and the company's very high free cash flow (FCF) and FCF margins, MSFT stock could easily be worth more than $3 trillion. This means its value is more than 33% higher at $410 per share, based on the Jan. 28 closing price of $308.26.

This was based on a projection that Microsoft would produce a 17% FCF margin going forward. That is because the company produced enough free cash flow in 2021 to equal 16.65% of its total sales.

As a result, I concluded that it would make $34 billion in FCF based on a $200 billion revenue forecast for the year to June 2022. And then using a 1% FCF yield metric, I set its target market value at $3.4 trillion.

Since this is 51.8% higher than its presents $2.24 trillion market capitalization, it implies that MSFT stock is worth $455.40 per share (i.e., 1.518 x $300.19).

Moreover, if we were to project out to the year ending June 30, 2023, the target market cap will be significantly higher. That is because 42 analysts surveyed by Seeking Alpha have an average revenue forecast of $226.4 billion. That is 13.2% higher than the projection for $200 in revenue for the June 2022 fiscal year.

In other words, sometime within the next year, MSFT could be 51.8% + 13.2% higher, or 65% higher. Even if this occurs, it could take a year and a half to occur. That would give it an annualized return of 39.6% the first year. The math on this is a little complicated. Suffice it to say, that this puts the target price of MSFT stock at $420.46 over the next 12 months.

Where This Leaves MSFT Stock

Barron's magazine recently reported that Morgan Stanley (NYSE:MS) analyst Keith Weiss recently reported that Microsoft's earnings per share (EPS) could rise to $20. This is based on a 15% compound annual growth in revenue for the next four years to 2026. He believes that its two-fold drivers are its Office product revenue and its Azure cloud computing and data managing platforms. However, most of this growth (two-thirds) will come from Azure.

In addition, he believes that the company's margins will expand over time. My projections were based on a static FCF margin of 17%. So if the company can grow its margins to over 20% then expect to see MSFT stock move significantly higher than I project.

This is what other analysts may be thinking. For example, the average price target of 37 analysts surveyed by Seeking Alpha put its price target at $373.68. Similarly, 28 analysts covered by TipRanks put its value at $376.28, or 25% over today's price.

Either way, look for Microsoft stock to move significantly higher, at least 40% to $420.26 according to my simple FCF model.

On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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