Key Highlights
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Despite a downturn in software stock markets, analysts tend to see Microsoft and Cloudflare as undervalued.
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Microsoft is effectively monetizing AI in its software and cloud sectors, with analysts projecting a 52% upside potential.
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Cloudflare is positioned to gain from the rise of AI agents, and forecasts indicate a 40% potential upside.
The S&P North America Technology Software Index, which tracks software stocks, has dropped 32% from its peak in September, deepening its bear market status. The downturn is mainly attributed to concerns regarding artificial intelligence.
Investors fear that AI might disrupt the software market by affecting demand and squeezing profit margins. Recently, Anthropic launched a tool called Claude Cowork that automates various tasks across departments such as sales and marketing.
Several experts, including Nvidia CEO Jensen Huang, argue that the current market selloff is irrational since many software firms are integrating AI into their offerings. Strategy expert Kriti Gupta of JP Morgan Chase highlighted this indiscriminate selling, suggesting that it may provide buying opportunities for investors willing to remain patient.
Most analysts believe that Microsoft (NASDAQ: MSFT) and Cloudflare (NYSE: NET) are, in fact, underrated.
Microsoft: 52% Upside Potential
Microsoft has a strong foothold in various software areas, such as office productivity and cybersecurity. The company has successfully integrated AI technologies into its products, which has resonated well with customers. CEO Satya Nadella noted a remarkable 160% increase in paid subscriptions for Microsoft 365 Copilot during the last quarter.
On the cloud front, Microsoft Azure continues to expand, although it still lags behind Amazon Web Services. Azure offers strong hybrid cloud support and integrates closely with enterprise software products.
Moreover, Azure connects with OpenAI models through API, acting as a crucial intermediary as businesses create custom AI applications, including those similar to ChatGPT.
Microsoft’s revenue for the last quarter was impressive, climbing 17% to $81 billion, driven by a surge in both consumer and commercial software sales. However, despite good overall figures, the stock price took a hit due to Azure’s revenue slightly missing expectations, and concerns about AI spending loomed large.
Wall Street anticipates a 15% annual growth in Microsoft’s adjusted earnings through fiscal 2027, which ends in June. This makes its current price-to-earnings ratio of 26 seem reasonable. Analysts have set a median price target of $600 per share for Microsoft, which indicates a 52% upside based on the current trading price of $395.
Cloudflare: 40% Upside Potential
Cloudflare delivers application, network, and security services, significantly enhancing speed and scale. The company safeguards around 20% of all websites and manages one of the fastest cloud networks globally.
Notably, Morgan Stanley has pointed out that Cloudflare plays a crucial role in supporting AI agents by providing the necessary infrastructure and seamless integration with major public cloud platforms, including those from Microsoft and Amazon.
Cloudflare’s recent financial performance was robust, with a 39% increase in paying customers and a net revenue retention of 120%. This indicates that existing customers are spending 20% more on average. Revenue grew 33% to $614 million, and non-GAAP earnings increased by 47% to $0.28 per diluted share.
Currently trading 31% below its all-time high, Cloudflare’s stock is still valued at 28 times sales, which seems manageable for a company expected to grow its revenue by 45% each year through 2027. Wall Street’s median price target for the stock stands at $245, implying a 40% upside from its current price of $175. Personally, I might start with a small investment in Cloudflare and consider adding more shares if the price drops further.
Is Microsoft Stock a Good Buy?
Before deciding on Microsoft stock, it’s worth noting that our team from Motley Fool Stock Advisor has identified other stocks they believe are currently better options. Interestingly, Microsoft didn’t make the cut in their latest recommendations.
So, if you’re curious about potential investments, some of the highlighted stocks have generated impressive returns over the years. For instance, an investment in Netflix when first recommended would yield significant profits today.
The average return for stock advisor members has been notably high, exceeding the S&P 500 by a wide margin. So, it might be advantageous to look into other opportunities before making a move on Microsoft.
