To The Moon

$Microsoft(MSFT)$

 This article argues why Microsoft Corporation stock is a buy after the release of its fiscal 2025 third quarter earnings report. The key takeaways are:

Microsoft's FQ3 2025 earnings report shows a strong Rule of 40 score of ~52, driven by 15% growth and a ~37% net profit margin. I see good reasons for the score to further improve as its cloud segment grows at a rapid pace. I expect this segment to become its largest profit contributor in the near future and carry higher margins. In terms of valuation risks, benchmarking MSFT’s P/E ratio by the sector average is misleading because most companies in the sector do not pass the rule of 40.

MSFT FQ3: rule of 40 score is 52

Microsoft Corporation stock’s latest earnings report (ER) is the most important catalyst surrounding the stock right now. To wit, MSFT announced its ER for FQ3 2025 on April 30, 2025. In particular, the growth from Intelligent Cloud (35% on a constant currency basis) outpaced the overall growth of 15% on CC basis, reflecting its momentum on the AI front.

As the contribution of its cloud-based revenue increases at rapid pace, I feel it makes good sense to review its ER from the framework of the so-called rule of 40. For readers new to it, the following introduction should be sufficient:

Wall Street Prep: The management teams of SaaS companies are often required to choose between rapid growth and expansion, or improving profitability – for which, the Rule of 40 has become a practical framework to balance the two concepts. The Rule of 40 – popularized by Brad Feld – states that a SaaS company’s revenue growth rate plus profit margin should be equal to or exceed 40%. Thus, the Rule of 40 measures the balance between a SaaS company’s growth rate and profitability.

MSFT FQ3 earnings: strong growth drivers

To better contextualize the subsequent discussion, the next figure provides MSFT’s scorecard over the past 10 years to provide a broader background. Here again, I computed the score as sum of A) its YOY quarterly operating revenue growth and B) its net profit margin. As seen, MSFT had reported a very consistent passing score in the past, even by the strength standard of net profit margin, illustrating the company’s superb balance of growth and profit. Note the score computed above is also noticeably above its score from the previous quarter (46.9).

A closer look at its specific growth and profit drivers gave me confidence that such a robust score will continue in the years to come.

MSFT valuations risks:

the average valuation of the overall sector serves as a poor benchmark for MSFT in my view. When benchmarked by other stocks that also pass the rule (for example, those studied in the following  McKinsey report), MSFT’s valuation is quite reasonable in my view.

That’s a staggeringly small number and a major missed opportunity. Data show that investors reward companies that are at or above the Rule of 40 with consistently higher enterprise value (EV) to revenue multiples. Moreover, the higher the number, the greater the gain. Top-quartile SaaS companies generate nearly three times the multiples of those in the bottom (exhibit). As seen, for SaaS companies that meet or exceed the rule, the overall EV/sales multiple is 12x and the multiple is as high as 22x for those in the top quartile.

Under this context, MSFT’s valuation is very reasonable. For instance, its EV/sales ratio is in the range of 10x ~ 11x as just mentioned, compared to the overall average of the 12x EV/sales multiple analyzed in this report.

More data and detailed discussion can be found in my following YouTube video:

https://youtu.be/wOOWh_aUdes