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‘Puzzling,’ Says Analyst As Microsoft’s Valuation Double That Of Energy Companies Despite Generating Half Their Cash Flow

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Microsoft Corp. (NASDAQ:MSFT) recently leapfrogged Apple to become the most valuable global corporation, thanks to the software giant embracing artificial intelligence in a big way. As the stock gathers mass, investors are left to ponder over the question whether the AI-induced upside is justifiable.

What Happened: Based on Friday’s closing price of $420.55, Microsoft market cap is at $3.125 trillion. Macro strategist and Crescat Capital partner Otavio Costa on Thursday shared a graphic comparing the Satya Nadella-led company’s market cap as well as its free cash flow generation to those of energy companies.

Microsoft’s valuation is nearly double that of the energy companies in the S&P 500 Index even as it generates half the free cash flow as these companies, the analyst said.

He called the statistics “puzzling.”

Puzzling. With a $3 trillion market cap, Microsoft is twice the size of the entire energy sector in the S&P 500, which generates double Microsoft’s annual free cash flow.

— Otavio (Tavi) Costa (@TaviCosta) February 8, 2024

See Also: Best Tech Stocks Right NowWhy It’s Important:  Free cash flow is a crucial financial metric, especially from a liquidity perspective. Profits often do not provide a realistic picture of a company’s financial condition and can be easily manipulated by including non-cash items.In contrast, cash flow offers a realistic picture of the cash available to the company, which is vital for day-to-day operations and capital investments. This metric is particularly significant in the current high-interest rate environment, as companies need sufficient cash on hand to avoid relying on high-interest loans, which could result in a heavy interest servicing burden.

Microsoft grew free cash flow over the years, although the metric flattened out in 2022 and held steady until the first quarter of 2023. It has been climbing steadily since then.

Source: Y Charts

Energy companies operate in a capital-intensive industry and have seen slowing free cash flow generation. That said, production efficiency and reduced capital spending following the pandemic boosted the free cash flow of energy companies.

Capex trends will likely reverse in the near-to-medium term as the resurgence in oil prices this year provides energy companies with the…

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