Technology stocks have been crushed significantly, with the Fed aggressively increasing interest rates several times this year. Rising borrowing costs impacted tech companies’ financials adversely. The tech-heavy Nasdaq composite lost more than 30% year-to-date.

The widespread tech sell-off led to investors dumping high-growth stocks, such as Microsoft Corporation (MSFT), trading at premium valuations. MSFT has declined 29% year-to-date to close the last trading session at $237.53.

In terms of forward non-GAAP P/E, MSFT is currently trading at 23.44x, 40.4% higher than the industry average of 16.7x. Also, the stock’s forward EV/EBITDA multiple of 15.46 is 36.2% higher than the industry average of 11.35. Furthermore, the company missed the consensus revenue and EPS estimates by 0.9% and 2.7%, respectively, in the last reported quarter.

Despite MSFT’s guidance of double-digit growth in its revenue and operating income for fiscal 2023, investors should instead opt for an attractively priced tech stock with better financials and growth prospects. VMware, Inc. (VMW) could be a good choice on that front.

This May, VMW announced an agreement under which semiconductor giant Broadcom Inc. (AVGO) will acquire all the outstanding shares of VMW in a cash-and-stock transaction valued at $61 billion. In addition, AVGO will assume $8 billion of VMware’s net debt. Under the terms of the deal, VMW shareholders will have a choice to receive either $142.50 in cash or 0.252 shares of Broadcom stock for each VMware share.

“Building upon our proven track record of successful M&A, this transaction combines our leading semiconductor and infrastructure software businesses with an iconic pioneer and innovator in enterprise software as we reimagine what we can deliver to customers as a leading infrastructure technology company,” said Hock Tan, President and AVGO’s CEO.

“We look forward to VMware’s talented team joining Broadcom, further cultivating a shared culture of innovation and driving even greater value for our combined stakeholders, including both sets of shareholders,” he added. Also, according to Patrick Moorhead of Moor Insights and Strategy, this acquisition looks like a good move from an investor standpoint.

VMW’s stock has gained 2.3% over the past five days to close the last trading session at $107.82. Given AVGO’s offer price of $142.50 per share, there is still a 32.2% upside left in the stock.

Here is what could influence VMW’s performance in the upcoming months:

Recent Development

This month, VMW launched the Next G-AI Research and Innovation Centre. The Centre will combine VMW’s multi-cloud infrastructure, advanced networking, and Modern Application Development expertise with the emerging Cloud Native development techniques, AI, and ML technologies to deliver a sustainable path to 5G and 6G technologies.

On September 29, the company unveiled new product innovations and partnerships that will enable communications service providers (CSPs) to modernize their networks cost-effectively and accelerate 5G core rapidly, RAN deployments, and lifecycle management. VMW expanded its VMware Telco Cloud Platform Ecosystem, which now supports 275+ VNFs and CNFs.

Solid Financials

In the fiscal 2023 second quarter ended July 29, 2022, VMW’s total revenue increased 6.3% year-over-year to $3.34 billion, while the combination of subscription and SaaS and license revenue came in at $1.74 billion, representing an increase of 15% from the prior-year period. Its operating income amounted to $566 million, up 7.8% year-over-year.

Furthermore, the company reported an operating cash flow of $397 million for the second quarter. Also, its free cash flow came in at $284 million.

Favorable Analyst Estimates

Analysts expect VMW’s revenue for the fiscal 2023 third quarter (ending October 2022) to come in at $3.36 billion, indicating an increase of 5.5% year-over-year. Also, the consensus revenue estimate of $13.54 billion for the ongoing year indicates a 5.4% year-over-year increase. The company has topped the consensus revenue and EPS estimates in three of the trailing four quarters, which is impressive.

In addition, the company’s revenue for the fiscal year 2024 (ending January 2024) is expected to rise 7.4% from the previous year to $14.54 billion. Analysts expect the next year’s EPS to grow 12.5% year-over-year to $7.43.

High Profitability

VMW’s trailing-12-month gross profit margin of 81.85% is 61.4% higher than the 50.72% industry average. Its trailing-12-month EBIT margin of 17.86% compares to the 7.22% industry average. And the stock’s trailing-12-month net income margin of 11.97% is 206.1% higher than the 3.91% industry average.

In addition, the stock’s trailing-12-month levered FCF margin of 27.02% is 224.5% higher than the industry average of 8.32%. Its ROCE, ROTC, and ROTA of 32.23%, 10.44%, and 5.62% compare to the industry averages of 6.45%, 3.80%, and 2.31%, respectively.

Discounted Valuation

In terms of forward non-GAAP P/E, VMW is currently trading at 16.33x, 2.2% lower than the industry average of 16.7x. The stock’s forward EV/EBITDA multiple of 10.78 is 5.1% lower than the industry average of 11.35. Likewise, its forward Price/Cash Flow of 11.56% is 27% lower than the industry average of 15.84x.

POWR Ratings Show Promise

VMW has an overall A rating, equating to a Strong Buy in our POWR Ratings system. The POWR Ratings are calculated by accounting for 118 distinct factors, with each factor weighted to an optimal degree. 

Our proprietary rating system also evaluates each stock based on eight distinct categories. VMW has a grade of A for Quality, in sync with its higher-than-industry profitability metrics. In addition, it has a B grade for Sentiment, consistent with its solid revenue and earnings growth estimates.

VMW is ranked first in the 51-stock Software-Business industry.

Beyond what I have stated above, we have also given VMW grades for Value, Momentum, Growth, and Stability. Get access to all VMW ratings here.

Bottom Line

This year’s widespread tech sell-off led many quality stocks to trade at valuations much lower than their intrinsic values. Despite the weakness in MSFT’s financials, the stock is still trading at a higher-than-industry valuation.

Given VMW’s robust financials, high profitability, and attractive valuation, it could be a better buy. Moreover, VMW’s shareholders are expected to benefit from the company’s acquisition by leading chipmaker AVGO.

MSFT shares were trading at $238.02 per share on Tuesday afternoon, up $0.49 (+0.21%). Year-to-date, MSFT has declined -28.77%, versus a -21.13% rise in the benchmark S&P 500 index during the same period.

About the Author: Mangeet Kaur Bouns

Mangeet’s keen interest in the stock market led her to become an investment researcher and financial journalist. Using her fundamental approach to analyzing stocks, Mangeet’s looks to help retail investors understand the underlying factors before making investment decisions. More...

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