Why is Microsoft's share price a hedge fund ‘darling’?

Microsoft’s share price is soaring as the stock once again tops hedge fund buy lists. But should ordinary investors follow suit and pick up the cloud giant’s share price?

Microsoft [MSFT] is yet again one of the top buys among fund managers, according to data compiled by Bloomberg. It’s easy to see why. Last year it was a widely backed choice as Microsoft delivered strong financial results, while this year growth is being driven by the current lockdown. Bloomberg itself labelled Microsoft’s share price a hedge fund 'darling’.

And with a large chunk of white-collar workers now remote working, Microsoft's share price has soared almost 16% off the back of its cloud-based businesses. A staggering feat considering the wider S&P 500 is down over 8% as its historic bull run comes to a crushing end. So should ordinary investors follow the hedge funds and buy Microsoft at its current share price?

Unsurprisingly, the two biggest sell-offs among hedge funds were ETFs tracking the S&P 500. Bloomberg uncharitably labelled these the 'cast-offs'.

Why are hedge funds backing Microsoft’s share price in 2020?

The simple answer is Microsoft's cloud technology, which helped the company crush analysts’ Q3 earnings expectations. Reported revenue came in at $35 billion, with earnings of $1.40 a share. Wall Street had been expecting $33.8 billion and earnings per share of $1.28.

Cloud services generated $13.3 billion in sales - up 39% from the same quarter last year. Azure experienced a 59% growth, while Office 365 commercial licence sales were up 25%. Xbox content revenue was also up 2%. While that sounds like small beans, gaming revenue had been either flat or negative for the past few quarters. Demand here is likely those stuck at home office workers looking for something to do.

But it’s not just strength in some products that is spurring on hedge funds. In the results, Microsoft saw growth across the board - from its server-side offering to enterprise services. Carter Henderson, director of institutional development at Fort Pitt Capital Group told CNBC:

“I think it’s really amazing to see all the segments of the overall business can perform in really any environment.”

Fort Pitt Capital Group counts Microsoft as its top holding. And Henderson told CNBC he expects Azure to be in strong demand, even after workers return to the office.

This is a sentiment shared by Microsoft CEO Satya Nadella. During the earnings call the Microsoft boss predicted a prolonged “hybrid” phase as offices get back to some kind of normality. This would see an increase in demand as more complex operations are shifted to the cloud.

Time to buy Microsoft’s share price?

But it's not all good news. While the impact of the coronavirus has been minimal for Microsoft, the earnings did see a decrease in transactional licences for small and medium-sized businesses.

For Q4 Microsoft expects $35.85 billion to $36.80 billion in revenue. This would see its slowest quarterly growth rate since Q1 2017, according to CNBC. Among the areas expected to drag are its onsite server business. This isn't really a surprise given the general trend is seeing a shift to cloud technologies.

Of the 34 analysts tracking Microsoft’s share price on Yahoo Finance, 27 rate it a Strong Buy or Buy. An average 12-month share price target of $193.94 would see a 5.64% upside on the current share price.

Will Microsoft continue to be a 'darling' of the hedge funds? This depends on appetite for its cloud-related businesses. Irrespective of the current crisis, Microsoft has seen big growth in this area for the past few years. If this continues, then hedge funds and investors may be rewarded.