From Legacy to Cloud: A Valuation of Microsoft’s Evolving Business Model

☁️💻 Business Overview

Founded in 1975, Microsoft began as a personal computing software pioneer but has since undergone a profound transformation. Once defined by Windows and Office, the company has strategically reinvented itself through bold investments in cloud computing, AI infrastructure, and platform ecosystems like GitHub and LinkedIn.

Today, Microsoft’s core growth engine is Azure, its cloud platform, which—alongside enterprise SaaS products like Office 365 and Dynamics—is driving both scalability and profitability. This shift from legacy software to cloud-first solutions has strengthened its competitive moat and positioned the company as a foundational layer of the modern digital economy.

Underpinned by robust free cash flow, disciplined capital allocation, and a 21-year streak of dividend increases, Microsoft’s evolution reflects not just a shift in products—but in how long-term value is created and sustained.

💵Revenue Exposure & Diversification

The revenues are geographically diversified over the following geographic segments:

• United States: 50.87%
  • 1-Year Revenue Growth = 16.83%
• Other countries: 49.13%
  • 1-Year Revenue Growth = 14.50%

Its also diversified across several business segments:

• Server products and cloud services: 39.87%
  • 1-Year Revenue Growth = 22.20% (5Y CAGR: 24.54%)
  • Estimated Operating Margin: ~45-50%
• Office products and cloud services: 22.39%
  • 1-Year Revenue Growth = 12.34% (5Y CAGR: 11.55%)
  • Estimated Operating Margin: ~50-55%
• Windows: 9.48%
  • 1-Year Revenue Growth = 8.08% (5Y CAGR: 2.65%)
  • Estimated Operating Margin: ~30-35%
• Gaming: 8.77%
  • 1-Year Revenue Growth = 39.03% (5Y CAGR: 13.56%)
  • Estimated Operating Margin: ~30-35%
• LinkedIn: 6.68%
  • 1-Year Revenue Growth = 9.23% (5Y CAGR: 19.37%)
  • Estimated Operating Margin: ~50-55%
• Search and news advertising: 5.13%
  • 1-Year Revenue Growth = 3.44% (5Y CAGR: 10.52%)
  • Estimated Operating Margin: ~30-35%
• Enterprise and partner services: 3.10%
  • 1-Year Revenue Growth = -3.87% (5Y CAGR: 4.40%)
  • Estimated Operating Margin: ~45-50%
• Dynamics products and cloud services: 2.64%
  • 1-Year Revenue Growth = 19.20% (3Y CAGR: 17.59%)
  • Estimated Operating Margin: ~50-55%
• Devices: 1.92%
  • 1-Year Revenue Growth = -14.76% (5Y CAGR: -5.04%)
  • Estimated Operating Margin: ~30-35%
• Other: 0.02%
  • 1-Year Revenue Growth = -62.18% (5Y CAGR: -57.03%)
  • Estimated Operating Margin: ~30-55%

🎯Key Insights & Assumptions

• Revenue Growth (CAGR): 5-Year Avg: 14.42% | Last Year: 15.67%
  • Expected to be maintained around ~15%, considering the increase rate of growth of the cloud business but also taking into consideration the size of Microsoft as a company.
• Free Cash Flow Growth (CAGR): 5-Year Avg: 13.12% | Last Year: 24.54%
  • Expected to be in line with the growth rate of revenues, around ~15%.
• Operating Margin: 5-Year Avg: 41.53% | Last Year: 44.64%
  • As Microsoft transitions and grows its business to higher margin business segments (like its cloud business Azure) from the lower margin segments (like devices), it's expected to also grow its overall operating margin to around ~50%
• Return on Invested Capital (ROIC): 5-Year Avg: 29.65% | Last Year: 34.41%
  • Expected to be maintain around the 25-30% mark, given its operating maturity and efficiency.
• Dividend Growth (CAGR): 5-Year Avg: 10.12% | Last Year: 10.29%
  • Expected to increase at 10-15% during the next couple of years, following the growth of Free Cash Flow (~15%).
• Dividend Payout Ratio: 5-Year Avg: 28.49% | Last Year: 25.42%
  • Expected to be maintained around this very healty range of 25-30%. Giving that the dividend has been growing a little less than the Free Cash Flow, it gives security that Microsoft can keep this very healthy payout ratio going.

📈Business Valuation

To assess Microsoft's intrinsic value, we'll use DCF as the valuation method:

• Discounted Cash Flow (DCF) - Intrinsic value is estimated by projecting Microsoft free cash flows over the next 10 years and discounting them to present value.

Microsoft is still a growing company, despite its mature state, giving its cash flows projections more importance for its valuation.

Discounted Cash Flow

📌 Key Assumptions

• Revenue Growth (CAGR) is estimated to be around 15% in Years 1-5 , tapering to 4.42% (risk-free rate) in perpetuity.
• Operating Margin increasing gradually to ~50% , driven by its transition to the higher margins of its cloud business and office solutions.
• Cost Of Capital at ~10.48% considering its global revenue exposure, the median cost of capital for each business segment and Moody's credit rating of Aaa.
• ROIC terminal value will be set to be maintained around ~30% (given its ~29.65% 5-Year Avg), given the maturity of its efficiency systems.

💰 Fair Value Estimate

Based on the DCF model, Microsoft's estimated fair value is $439.88, suggesting that currently the stock may be overvalued.