Microsoft's Future Returns

A compelling investment thesis emerges when considering Microsoft's performance. With a remarkable 15.91% Internal Rate of Return (IRR), it demonstrates a significant outperformance in the market, offering a substantial margin of safety. Despite the exuberant stock market rally driven by the June 2021 COVID stimulus, Microsoft has not only caught up but surpassed its historical peak in EV/EBITDA multiple in 2021.

This upswing largely reflects the optimistic rally in artificial intelligence (AI) and the robustness of its various business segments. Microsoft's enduring legacy businesses are fortified by high switching costs, notably in Microsoft Office, Azure cloud platform, Windows OS, and productivity/collaboration tools such as OneDrive and Microsoft Teams.

The company has also accumulated substantial intangible assets through strong branding and strategic acquisitions, further enhancing its market capitalization. Microsoft epitomizes diversification, recently fortified by the successful acquisition of Activision. Satya Nadella's far-reaching vision for a cloud-first, mobile-first, and highly innovative company positions Microsoft as an indomitable force for the next decade.

With a projected double-digit growth over the next two years, followed by moderately high single-digit growth and gradually slowing to mid single-digit growth in the 2030s, coupled with expanding margins and a 25 EV/EBITDA multiple alongside a 2.4% Free Cash Flow to Equity (FCFE) yield, Microsoft stands poised to outperform the market with a substantial 60% margin of safety.

Historically, Microsoft has maintained a Return on Invested Capital (ROIC) exceeding 30%, an exceptional achievement for a company of its magnitude, especially considering the maturing growth trajectory of its legacy businesses. While its valuation, as measured by the EV/EBITDA metric, commands a premium, this premium is justified by its robust competitive advantages, adept management guided by a compelling vision, and the consistent generation of incremental returns on invested capital through forays into emerging sectors like AI. These factors, in conjunction with its formidable ROIC, render the impact of its valuation on overall returns comparatively negligible.