Why Microsoft's share price isn't one of the FAANGs

This article was originally published on Opto - Understand What Really Moves Markets.

Aside from the market sell-off in March, the stock has been on an upward trend, climbing more than 388% in the last five years from $42.54 to $210.28 (as of 17 August).

Despite being one of the few companies in the world to have a market cap over $1trn, Microsoft's (NASDAQ: MSFT) share price growth and strong underlying business don't seem to be enough to get it included in the US market's exclusive tech stock group: the FAANG made up of Facebook, Apple, Amazon, Netflix and Google.

The acronym has become synonymous with fast growth, disruptive innovation, smart technologies and software solutions that are purported to transform the way we live and work. The coronavirus pandemic seems to support this claim, but could its exclusion of Microsoft suggest the FAANG is outdated?

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Cast aside 

While Microsoft is widely considered to be of the big five tech companies in the US, Netflix beat the giant to inclusion in the acronym first popularised by Jim Cramer, CNBC's Mad Money host, back in 2013. The streaming giant's inclusion came down to the notable gains that its share price was making at the time. 

Netflix's share price has risen more than 6000% since 1 January 2010 through 17 August's close. In the first half of the last decade, it grew 533% and 865% in the second half. In comparison, Microsoft has risen 774% since 1 January 2010 through to 13 August, growing 74% between 2010 and 2015, and 285% between 2015 and 2019. 

Netflix's growth story is a remarkable one, whereas Microsoft has been more of a slow burner.

Slowing cloud growth 

However, this growth story is changing. There has been blistering growth in cloud services recently, accelerated by COVID-19 and the uptick in remote working. Microsoft will be at the front of the queue of companies lining up to reap the rewards, making this the tailwind that could push Microsoft's share price higher over the next three to five years. 

According to data from Statista, Amazon currently leads the cloud services market with a market share of around 33% - two to three times Alphabet's share. Microsoft is second.

In its fourth-quarter 2020 earnings, Microsoft delivered intelligent cloud revenue of $13.4bn, up 17% year-over-year. This surpassed the $13.11bn that analysts polled by FactSet had expected it to post. Within the cloud segment, revenue from Azure rose 47%.

The company's Azure revenue growth has been slowing down for several quarters - down to 59% in Q3 2020 from 76% in both Q2 and Q1 2019. In the first quarter of fiscal 2018, the year-over-year growth had been 90%. 

Microsoft isn't alone in seeing revenue from its cloud segment slow. Amazon Web Services has been declining gradually as well. 

Azure shows resilience 

During the latest earnings call, Satya Nadella, Microsoft CEO, said that COVID-19 has shown businesses that build in digital capabilities, powered by the cloud, are more likely to survive disruptive events. They also become more resilient.

While the coronavirus may have resulted in some companies cutting IT budgets and, consequently, spending on cloud, the pivot to remote working and increase in businesses embracing digital transformation could bode well for the company's cloud segment in the long-term.

Leo Sun, a Motley Fool contributor, says that the decline in cloud revenue growth may concern some investors, but it is no cause for alarm. 

"Microsoft is still growing at an impressive rate for a 45-year-old company, and the tailwinds from Nadella's 'mobile-first, cloud-first' strategy - which was launched six years ago - are still generating impressive gains," he wrote.

"Investors should keep track of Azure's growth, but they shouldn't panic about its gradual slowdown, since maintaining a 60% to 70% growth rate over the long term would be tough for even the fastest growing businesses."

Dan Inves, an analyst at Wedbush, wrote in a note to clients: "We continue to believe Microsoft is the core cloud name to play this transformational secular trend as well as for the other side of the dark valley." He reiterated his rating of Outperform and raised his price target from $220 to $260. 

There are 35 Wall Street analyst ratings for the stock on MarketBeat. An overwhelming majority of 31 are a Buy, three a Hold, while the remaining is a Strong Buy. The consensus price target is $213.82. 

Ultimately, the company's strong position in the cloud arena should help propel Microsoft's share price forward, making a case for it to break up the FAANG class. 

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