Microsoft Stock Is Off Its Highs - How Can Value Investors Can Play This?

Microsoft Corp (MSFT) stock has been down 8.7% since its FY 2025 Q2 results were released on Jan. 29. Higher capex spending reduced its free cash flow (FCF) by 29% year over year (YoY). 

The market doesn't like this, especially since management guided that high capex spending will continue. But value investors can take advantage

MSFT stock's weakness provides a unique opportunity for value investors. They can get paid by setting a slightly lower buy-in target. This can be done by selling short out-of-the-money put options in nearby expiry periods. 

For example, short-put yields are very high at 1.50% for a one-month expiry. This article will explain how investors can do this.

MSFT Stock is Cheap Here

MSFT closed Friday, Feb. 14, at $408.43, off 8.7% from $447.20 on Jan. 28, just before releasing its results for the quarter ending Dec. 31, 2024.

MSFT stock - Barchart - Friday, Feb. 17, 2025

As a result, it trades for less than less than 31x forward earnings for the year ending June 30, 2025, and about 27x for the next year. This is below its 5-year forward P/E multiple of 31.76x according to Seeking Alpha and 32.05x according to Yahoo! Finance.

In other words, MSFT is undervalued here, after its recent tumble. But now dramatically so. Let's look at this more carefully.

Lower Free Cash Flow and FCF Margins

Revenue was up 12% YoY for the most recent quarter, and its operating cash flow rose 18%. However, due to significantly higher capex spending, its free cash flow (FCF) fell 29% to $6.5 billion, from $9.1 billion a year ago.

Moreover, its FCF margins (i.e., FCF / revenue) fell from 14.7% a year ago to 9.3% this quarter. The reason is that the company's capex spending on cloud and AI investments rose 62% YoY from $9.7 billion a year ago to $15.8 billion this past quarter.

Moreover, management said this level of capex spending will continue. That implies that its lower FCF margins will continue at least until revenue growth picks up.

MSFT Q2 deck - Jan. 29 - page 6

Price Targets

As a result, if the company roughly makes just 10% FCF margins its FCF could be just $29.7 billion over the next year. 

For example, analysts estimate revenue for the year to June 30, 2025, will be $277.2 billion and $316 billion next year, or $297 billion on a run-rate next 12 months (NTM) basis:

   $297 b NTM revenue x 10% FCF margins = $29.7 billion FCF NTM forecast

As a result, using a 1.0% FCF yield metric, Microsoft's market cap is worth about $3 trillion:

   $29.7 b / 0.01 = $2,970 billion = $2.97 trillion

That is roughly close to its present market cap of $3.03 trillion as of Friday.

The only realistic way to estimate a higher market cap is to expect a higher FCF margin. For example, over the last 12 months (LTM), Seeking Alpha shows that Microsoft generated $70 billion in FCF. That represented a much higher FCF margin on sales:

  $70 b LTM FCF / $261.8 b LTM sales = 26.73% FCF margin

So, if we assume that Microsoft can expect its higher capex spending will eventually lead to higher FCF margins, or 12% of sales, its NTM FCF could hit $36 billion:

  $297b x 0.12 = $35.64 billion NTM FCF

So, using a 1.0% FCF yield, its forward market cap could hit $4.45 trillion:

   $35.64b NTM FCF / 0.01 = $3,564 billion market cap

In other words, we might expect a 17.6% rise in MSFT stock to $480.31:

  $3564 b forecast mkt cap / $3,030 billion mkt cap today = 1.176x

  1.176 x $408.43 = $480.31 target price

Analysts agree that MSFT is cheap here. The average of 57 analysts surveyed by AnaChart is $508.05 and AnaChart shows that 37 analysts have an average price target of $462.45 per share.

The problem is this could take a year to happen, and only if the company's FCF margins appear to be rising. So, how can value investors play this now?

Shorting OTM Puts

One way is to set a lower buy-in price by selling short out-of-the-money (OTM) put options in nearby expiry periods. That way an investor can get paid with immediate income while waiting to buy in at a lower price.

For example, look at March 21, 2025, expiry period, one month from now. It shows that the $400 exercise price, 2% below Friday's trading price, trades for $6.00 per put contract.

That provides an investor willing to buy 100 shares at $400.00 anytime over the next month an immediate yield of 1.50% (i.e., $6.00 / $400.00).

MSFT puts expiring March 21 - Barchart - As of Friday, Feb. 21, 2025

For more risk-averse investors, selling short the $390.00 strike price, 4.5% out-of-the-money, produces an immediate yield of 0.936% (i.e., $3.65/$390.00). That is almost 1% over the next month.

That means an investor who secures $39,000 in collateral with their brokerage firm, after entering an order to “Sell to Open” one put contract at $390, will receive $365 immediately in their account.

Moreover, the breakeven price will be $394.00 for the $400 strike price (i.e., $400-$6.00 premium received), or 3.5% below today's price. For the $390 strike price, the breakeven price is $386.35, or 5.4% below the Friday close.

The bottom line is this is one way to set a lower buy-in price over the next month. It may or may not result in an unrealized capital loss. But either way, the investor gets to keep the income generated. So, if repeated over the next quarter, the expected return (ER) could be 4.5% (i.e., 1.5% x 3). That will help offset any potential unrealized capital loss.

Given Microsoft's higher price targets, this is a disciplined way for value investors to play MSFT stock.