Episode 81 | Microsoft’s Investment Value Beneath Recent Sell-Off

In Episode 81 of “Market News with Rodney Lake,” Professor Lake, director of the GW Investment Institute, assesses Microsoft, as current news highlights the company’s position in the AI race, with a market cap of over $3 trillion, and a recent decline in year-to-date return. With $305 billion in trailing twelve-month revenue growing around 16%, strong free cash flow, and a fortress balance sheet, Lake gives high marks to both the business and management. He credits Satya Nadella for repositioning Microsoft toward cloud and AI, and for reframing AI CapEx as a necessary “play-to-win” strategy. Alongside peers like Amazon, Google, Nvidia, and Tesla, Microsoft is deliberately deploying capital to capture long-term, non-linear productivity gains over the next three to five years.

Transcript

Thank you for joining Market News with Rodney Lake. This is a regular program for the GW Investment Institute where we talk about timely market topics. I'm Rodney Lake, the director of the GW Investment Institute. Let's get started. Welcome back to Market News with Rodney. Like. I'm your host, Rodney Lake, on today's episode coming to you from the George Washington University School of Business.
Duquès Hall. Duquès family studio. This is a production from the GW Investment Institute, where our students manage just over $11 million of real endowment money here at the George Washington University School of Business. Today's episode is going to be on Microsoft. So we haven't done an episode like this in a little while, so we're gonna bring it back.
And so this is the type of work our students do in our classes. We're going to use our framework by the GW investment into business, management, price valuation and balance sheet to evaluate Microsoft. Microsoft is one of our holdings. Microsoft has absolutely been in the news. People have their concerns about it. So I thought maybe let's take this opportunity to pause, pull back, let's check out Microsoft.
Let's see how it's doing. Let's use the framework to evaluate it today. This is coming up on mid February 2026. So let's really think about you know where is their position? How's the business doing? What do we think about management? What do we think about the valuation right now? And you know what's the balance sheet looking like at the moment?
So let's kick it off. All right. So let's talk about the company Microsoft. So I think many people know Microsoft, but let's get a few stats on the company. So let's go here. So right now again, sort of wild data even further here. 2/20/2026 is when we're recording this share price for 420.31.
Today, while we're recording this. And so what's the year to date number for the returned -13%? That's why we're talking about it. Like should we be concerned as an example? It's up today. But should we be concerned about this? The year to date numbers are looking tough. Where does that put the market cap for Microsoft? That puts the market cap at just over $3 trillion.
So you know they're doing okay. $3.12 trillion. And so obviously a very large companies, one of the largest companies in the world. Now, this is obviously, a company that is well known and people, use their products if you're using, you know, Windows, if you're using the office products, if you're start if anybody uses copilot, put it in the comments and let us know, because I don't know anybody that's using copilot.
But if you are, let us know. I love to hear about it. And so let's now think about okay. Well what's the revenue look like? We got the market cap. You know 3 trillion. But what's the revenue look like? Alright. So this is the, if you look at the last 12 months, this is $305 billion. So look, this is, these are huge numbers.
They have a June 30 fiscal year, by the way. And so if you do the trailing 12 months, through the end of the calendar year 12/31, which is not their fiscal year, fiscal year, June 30, but the trailing 12 months, 305 billion, so these are very good revenue numbers. And it grew 16%.
So that that's a very good growth number. So you're talking about an enormous business. And it still grew 16%. And it's on track basically to grow 16% for the full fiscal year June 30th, 2026. This year, 327 is the number up from 281 for the full fiscal year for 2025. And so 16% growth number of 300. You know, 280 billion to 327 billion.
These are enormous numbers. And so those are pretty more than pretty good growth rates for that. So now what's the profit margin? So that's a lot of revenue. But what's the profit margin? So you're talking gross margins right now that are at 68% for the trailing 12 months and so projected about 68% just to tick down from that for the fiscal year.
But let's go back, how consistent has this been? This is one of the things that we talk about. Should we be, you know, at all worried, on something like that. And we'll go back to the revenue number for one second after we do this. So the gross margin 2022 68, 23 68, 24 69, 25 68, almost 69, 68 again for the trailing 12 months through December 31st, 2025, projected 67 projected 67 in 27.
So as investors, at least for that number, that's not a concern. Gross margins continue to do well. So they continue to be performing. They're not a big concern. Now, one of the things that people may be concerned about is that you have a slight tick down, in the projected 2027, to go back to that sales number, I talked about the revenue number.
So from 327 projected 6/30 this year, 2026 to next year,  378 15%. So that's only modestly down. You're talking about these enormous numbers and huge gross margins. You know, that's still good. And so but the market is absolutely concerned that maybe Microsoft is spending too much CapEx, or maybe they're not finding their way. Or maybe this relationship with OpenAI is not working out the way that people want it to.
And, you know, it looked like early days. But that relationship on the business side, that Microsoft was positioned super well in the AI game, and really they were backing the leading and at the time, really the only option for the large language models that open to consumers, that people are using. And that growth rate took off. And so and then Google had borrowed and it really didn't work out.
And now it's Gemini and it's working out much better. And so Microsoft looked like they were in that early lead along with OpenAI. Now that you know has shifted. And I think people are more concerned there. So that's something that we have to think about. But let's let's drop down and look at the the net income here.
So net income for the trailing 12 months, $111 billion, and the projected is 125 for the full year again, June 30. And that's up that or sorry that the gross margin or rather the net margin excuse me is 38%. So let's go back. Let's think about, you know, should we be concerned here? Is the net margin dramatically different?
Is it, is it, you know, declining? So if you go back and you look at the net margin numbers 2022 34, 23 34, 24 36, 36 in 25, and then 36 again, and now going up to 38 and 37. So actually the net margins have modestly these are already great net margins for such a large company. They're good and so no reason to be concerned.
And so if you look at okay well earnings per share have grown. And so earnings are growing. Earnings per share is growing. So not a huge concern. And that's actually gone up significantly. So that's nothing. It's not something that we should be super concerned about. And so but what are people concerned about? People are concerned that Microsoft is spending too much on the CapEx.
So let's dive into the CapEx budget here while we're talking about the business. Now, if you listen to a prior episode, you know, I am pro spend the money right now because I do think this is a winners game and you have to play to win in this game. Now, it doesn't mean that you're going to allocate that money appropriately.
So that is up to the management team. We'll talk about that and Nadella here in a second. But you know, I think if you want to be in the game and you want to win at scale, that you're going to have to play at scale and you're going to have to allocate the capital to do that.
And I think the, the best informed companies Amazon, Microsoft, Google, Tesla, they're doing that. I think that they understand, the game. And I think they understand that the allocation of capital, they have to get it right. But I think that they step one is that they got they I think they see the imperative that they have to be in that game.
So if you look at this but this is the concern. So look at the CapEx budget. So the projected here 105. And I think it's going to be bumped up even slightly for the full fiscal year 2026 and then expecting even more, for 2027, 124 per year. Now let's dial it back and see how what's the change here?
So if you go back, for example, just to 2022. So that's not even that long ago. You're talking four years ago, 2022 June 30, not even not even a full four years. Right. Coming up on a full four year, the CapEx budget, any guesses out there? $23 billion. So that is now a fraction of what, you know, this is going to be coming up this year.
So less than, 25% really like 20%. So it's 5x in four years more and it's going to be more than five x. That is a huge increase over a fairly short period of time. And that is for the AI game. And so if you look at the next year, 28 billion in 23, 44 billion in 24, 64 billion 25 and so you can see it ramping 83 billion, for the trailing 12 months through December 31 and the projected full year, over 100 billion probably closing in on, let's say, 145 billion for the full fiscal year 2026 ends on June 30th, and the projected over 100 billion again in 2027.
So that's where the concern is coming from. So when we look back okay, well, we talked about the numbers for the business. So let's give some scores here. Now that's part of the framework. You know 1 to 10. Remember not investment advice, entertainment purposes and educational purposes only. So out of ten what are we given the business I think we I think we can give right now the business, a nine or a ten.
It's very good. High gross margins, high profit margins, good growth rates growth and earnings per share. You know, this is a good business. So right now again that can be disruptive. We're taking a snapshot when we're doing this evaluation. So where you know but we obviously have to make some projections. And so but you talk about Microsoft Azure to talk about productivity, Office 365.
And certainly, these products are pervasive throughout corporate America, and they're a big enterprise client. I don't think we'll spend a ton of time here on management, but let's talk a little bit about management. So they've actually been these you know, we talk about capital allocation on the CapEx budget that's driven by management. So, you know, even though I think that there are issues, they're still going to give them a nine, on the management right now.
Satya Nadella doing a great job. He's the one who repositioned the company away really from windows. Let's save that over utilize that to really cloud based and now AI based. And so I give him a lot of credit. So I do think the CapEx budget is justified. And again, I think these companies that are doing that are playing to win.
And so if you give a nine there, you could drop it down to an eight if you want. But has done a very good job and so business again we went more over that. The management obviously interconnected with the CapEx budget. That is the capital allocation. And I think as an investor, business person, analyst, you should be watching that super closely.
Those things are, obviously tied together. The management obviously needs to run the business and allocate that capital. And when that free cash flow comes out, that's you have to decide where it goes. So I'm giving a ten to the business and nine to the management right now. And so now we're going to talk. Let's go back to price versus valuation.
We might mention management again here, but let's go on onto the price versus valuation. So how is Microsoft doing? And so this is a this is a solid company. This is a stable company and stable earnings. So I think we can just use the PE to talk about that. So if you look at where is the PE now?
So the forward PE here is that crazy. Because it's sold off again. It's -13% year to date down. And so if you look at the forward PE you're at 25 times that. It's not crazy. That is not a crazy PE. You're approaching market multiple really for a fantastic business with high gross margins and high net margins and growing and is and is at least has a seat at the AI game, it may or may not win, and be one of those winners, but it's definitely in the game and it's playing to win that game.
And so if you look at that multiple, it's like, well, that's not a crazy multiple to pay for such a fabulous company that has a great track record, that has great assets, that has a great network effect. But people again are concerned and that has sold off considerably. Again, trading at 423 right now, as we talk about it.
So all right, so let's go back to the scoring here. So if we give that score, you know, you can probably give that a solid seven, right? If it were even lower, maybe you could give it a higher score. But, you know, I think that's a solid seven, on a price versus valuation. Maybe you could give it a slightly better, slightly worse.
But I think that's a solid seven on the, on the PE there again, the forward PE is is nothing crazy 25 times I think is very reasonable valuation at the moment for this. Now let's get into the balance sheet. All right. This is pretty easy. So for the balance sheet here for Microsoft I mean what can you say about this fortress balance sheet?
It is maybe a ten here. But let's talk about it. So, what do we have on on the balance sheet here? 123 billion of debt and 89 billion in cash right now through 2025. But if you look at, okay, well, what's the free cash flow? $77 billion. And so you're definitely not, you know, overly concerned about the balance sheet, for Microsoft.
And you're not you know, you're not, you know, worried about it. So one of the other things, so you have some net debt as of now, but not, you know, with the free cash flow. Not worried about it. And so let's then look to the interest coverage ratio. So for everybody remember that's Ebit earnings before interest and tax over total interest expense.
What's that number right now? 53 times. And so over ten gets you more comfortable 50 times. No problem. This is a fortress balance sheet. So we're definitely not super concerned about Microsoft's balance sheet. I would call this a fortress balance sheet and not really a thing to worry about. Now, when you're spending this much money, you know, that's something that we have to watch when you're spending.
So if you're generating free cash flow of 77 and you're spending 125 and or more now, the balance sheet will have to have closer scrutiny moving forward. And that may change. So that's something as an analyst business person, investor, that we're going to need to watch and pay attention to. But as of right now this is a fortress balance sheet.
I expect it to stay a fortress balance sheet. Now the projected free cash flow is actually still expected to be quite high. So if you look at even after these enormous CapEx numbers, and so the 77 billion of free cash flow is through 12/31/2025. That's after spending 83 billion on CapEx. And so the projections so let's use the current consensus projections.
I think it's going to be higher than this. The 2026 fiscal year for them is June 30th. And so that is a 105 projected CapEx that still generates 71 billion in free cash flow. And then the next year, consensus projections for 2027, June 30, that is 125 as a round number and 84 billion, and free cash flow.
So that so that's CapEx and free cash flow. So again here we're not super worried about the balance sheet. Certainly not now and not really in the near and medium terms for Microsoft. Now if they accelerate their CapEx budget even more than they're expecting right now for the AI play, I think the you know, we're going to have to think about that we talked about in the prior episode that Google is issuing a $100 bond to help, to help finance rather, the CapEx spend on the AI.
So we'll see what Microsoft does in this category if they do something similar. So let's now let's go back to the framework. Let's let's really tie all this together. So I think at least now again this is a this is a ten I don't see how you could say it's really anything other than a ten given, the cash on hand, given the free cash flow.
And even with really high spending expectations and current spending expectations, there's just generating a ton of free cash flow. Interest coverage ratio, remember Ebit over interest expense that is fifth over 50 times right now. So we're definitely not worried about that. So let's let's kind of do a recap for all these categories. And then we'll give a total score.
All right. So back to the business. Now everybody knows the business. And let's just review that the gross and net margins as of now. So when we talk about the revenue side and remember 3.1 trillion market cap, revenue of 300 billion through 12/31/2025. Remember, that's not their fiscal year, but that's the trailing 12 months gross profits of 200.
That's a 68.6, if you like, to get to the decimal point there. But let's say 68% gross margin. Fantastic. Then you talk about, okay, what's the net income, 107 billion. That's a 36 percent net margin. That is fantastic. And so again, then generating 77 billion in free cash flow. So when we go back and we talk about, okay, well what's the business score I think that's a ten.
You could say maybe it's a nine, maybe it's an eight. But you know, we can put it somewhere in that category. Right now. They are dominant. They are in the AI game and they are playing to win. And again, I think that's the right move. Now. Management. Satya Nadella we're talking about such a fabulous management. They reposition the company for the cloud.
And Microsoft Azure has a great job. They're very focused now on AI as well. Now it looks like they had an earlier lead in that because they were at the table with OpenAI. Now that partnership doesn't look quite as strong as it did. In the past. Certainly not out of the gate. Copilot is not really, progressed, I think, as well as many people thought.
And again, if you're using copilot, I'd love to hear from you because I don't think it's quite useful at the moment. But maybe you have a different take. I think most of the other frontier models are doing much better. I know, they rely on some of the back end stuff from OpenAI. But in any case, I think management has done a fabulous job.
You know, credit where credit's due for being early and certainly at least recognizing where the game was going and having that partnership. I don't think it worked out probably the way that they want right now, and maybe they won't say it that way. That's my take, not their take. But, you know, maybe they would be better off with their own frontier model.
So next up here, you know, it's price versus valuation. And again, back to management. Maybe for a second I'm giving them a night price versus valuation. Let's just check the stats. Again before we go back to the score. So if you talk about the forward PE 25 times, that certainly nothing, ridiculous. And again, I think that as a market multiple, you know, in that neighborhood, not bad.
But we can, you know, ding it a little bit, just call it sort of average here. That's a seven. But, you know, you can maybe say it's a little higher, a little lower balance sheet again, not super worried. Very clean balance sheet. Interest coverage ratio 50 times. It does have some some net debt, but nothing to be worried about and generating a ton of free cash flow.
So, not really worried about that. So fortress balance sheet. So when we put all that together, what does that get us? So the composite score, if you use again business at a ten, management at a nine, price valuation versus at a seven, and balance sheet at ten, and again, you could modify some of these scores up or down.
Not above ten. And in our framework here that's a nine. So look right now Microsoft looks okay. Now I think the market is concerned if you go back, you know, the year to date number here, is down 13%. So if we're saying oh the composite score using the GW investment framework right now is a nine, Microsoft still looks like the favorable company.
Remember Non-investment advice entertainment, educational purposes only. It looks solid, but I do think obviously you have to think about where do we go from here, what's going to happen from here? Are they going to be right on these massive CapEx budgets for the AI game now? I don't know, and I don't think anybody really knows what's going to happen if you do.
Let us know if you're from the future as an example. But what we can say is at least my view on this is the hot take, is that the companies that are playing to win obviously have a chance to win where success is in the set of outcomes. And so, it may not be assured, but certainly I do think that the AI game is is for real.
For real, if you like to say it that way. And I do think the companies that are playing to win are going to have a real shot at winning, obviously. And I think when you're doing this at scale, it's going to make a significant difference. Not just this year, next year, in the year after, but certainly in the next 3 to 5 years.
And I think companies like Microsoft, Google, Amazon, Tesla, Nvidia, they are playing absolutely playing to win. And again, this specific capital allocation has to be evaluated. You have to see if it's efficient. You have to see if it works. But the start for all these companies, which I'm a fan of, you got to put the money to work.
You got to go out there and try to win this game because the productivity gains is a multiplier effect, and I think it's going to be a non-linear return for the companies that deploy this capital. I think the ROI is going to be very high, and I do think it's going to be winners and losers. And I think you got to set yourself up for success.
And I think that means you need to deploy some capital to try to make that work. Now, none of the none of us know how this is all going to turn out. But I do think you have to play to win. And Microsoft, I do think, is playing to win. Now. That's it for this episode. If you like our episode, keep watching.
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