Summary

• Microsoft’s Majorana chips mark a groundbreaking quantum computing breakthrough, potentially bringing practical quantum computers closer to reality.

• The market has largely ignored the news, as quantum computing remains in its early stages with uncertain commercial timelines.

• Despite this, Microsoft holds a significant edge over competitors in quantum hardware, making it a strong long-term bet.

• Even without the quantum advantage, MSFT is attractively valued with solid short-term growth prospects.

• Given its growth potential and quantum leadership, Microsoft is a strong buy with a compelling risk-reward profile.

Microsoft Inc, the $3 trillion tech giant, has recently been making the news. The company announced the launch of the Majorana 1 chip, which brings quantum computing within grasp. Previously believed to be decades away, Microsoft's leadership claims that its chips have brought the inception of quantum computers only a matter of years away.

Using a principle that was theorized in the 1930s, Microsoft's research team has effectively "solved the physics" to allow the breakthrough to come to light, effectively creating a fourth state of matter.

While the news is undoubtedly game-changing, and is being seen as revolutionary among physicist circles, the market continues to show indifference. This is not surprising, considering that, despite the breakthrough, quantum computing is still in pre-infancy. It is still unclear about when and how the development will lead to tangible benefit for the company.

In this analysis, I demonstrate that, although, quantum computing may still be several years away, Microsoft does possess an edge over its rivals, through its Majorana chips. This edge, I believe, is well worth betting on.

In fact, even without considering in this long-term quantum advantage, Microsoft is still attractively priced given the immediate growth it offers. You don't lose anything by going long on the stock, while there is so much to gain. In fact, if the company continues to play its cards right on the quantum side, we could see an explosive surge in a few years.

In my opinion, the risk-reward dynamic is beyond compelling. For these reasons, I rate MSFT as a strong buy.

Ground-breaking Launch of Majorana Zero modes

For those who are unaware about the latest news in tech, Microsoft just announced a major milestone in its 20-year pursuit to develop reliable methods of attaining quantum computing. It unveiled the groundbreaking Majorana 1 chip, which is the culmination of decades worth of research in the quantum sciences.

So what exactly is this all about?

Without getting too technical, let me dive right in.

What Microsoft effectively achieved is something no one has come close to before - the physical realization of Majorana zero modes, a concept that had first been theorized by the Italian Physicist, Ettore Majorana, back in the 1930s. These are essentially a type of quasi-particles that are their own anti-particles. Without getting into the science of it too much, these particles have the ability to remain coherent, even in environments that would typically disrupt quantum states.

Traditional qubits, while quite powerful, are extremely delicate, despite all the progress made in quantum computing in recent years. Given prior limitations in quantum research, qubits were prone to losing quantum information in the face of even the tiniest disturbances. This has always been among the most significant barriers to developing practical and scalable quantum computers.

Microsoft delivered the physics breakthrough that was needed to overcome this issue, through Majorana zero modes. These modes use a newly achieved state of matter known as the topological phase, which had only been theoretically proven in the past.

Practically achieving this is a real game-changer in quantum mechanics because it brings about a self-correcting property in qubits built around Majorana zero modes. It essentially fixes the quantum decoherence problem, providing the stability needed to construct larger systems, such as workable quantum computers.

The Possibilities of Quantum Computing

So what are the possibilities now that this obstacle has been overcome by the genius minds at Microsoft? Well, there are a whole host of transformative applications that were previously thought of being in the science fiction realm, but are now within reach.

The most immediate domain to come to mind is that of quantum simulation.

Typically, quantum systems have always been difficult to simulate on classical computers due to the exponential complexity of these interactions. With quantum computers set up, it would be possible to directly model the behavior of materials down to the atomic level. This could revolutionize pharmaceuticals and accelerate drug discovery by accurately predicting molecular interactions. It could also enable the design of completely new materials that are tailored for specialized needs such as super-conductors or, for example, construction material with self-healing properties against wear and tear.

It is important to keep in mind that quantum simulation is only the most immediate area of application that would be revolutionized through the emergence of quantum computing. Beyond this, quantum algorithms could potentially solve some of the world's most complex problems, and give rise to optimized financial modelling frameworks, enhanced supply chain management systems, while also revolutionizing cryptography and cyber-security.

Overall, I believe quantum computing would bring about a revolutionary paradigm shift, and the introduction of Majorana zero modes is the key towards unlocking these possibilities.

Market Reaction

Interestingly enough, the market reaction to Microsoft's announcement has been nothing short of, well, muted. Since the announcement made on the 19th of February, MSFT's stock price has slipped by 1.6%, and it has been trading at volumes close to its average levels. So it would seem that the market may feel that it is too early to determine if the breakthrough would add a premium to the company's stock. To be fair, this is understandable, as it may yet take several years for Microsoft to translate this research into a commercially viable quantum computing platform.

This cautious sentiment among investors makes sense given the inherent uncertainties of a field as nascent and pioneering as quantum technology. The market is usually a lot more dynamic when there is a clear perception that will directly result in a tangible benefit, such as an improvement in the top or bottom line, or a prospect towards capturing greater market share.

In other words, the market reaction is likely to remain soft until a visibility threshold is reached. Until this does not take place, the market isn't likely to pay much heed to reports of such developments. An interesting example is that of OpenAI. Although the company was founded back in 2015, as a research organization, hardly anyone recognized the group until it launched GPT. Earlier this month, Softbank was reported to be negotiating a funding round for OpenAI, applying a valuation of about $300 billion for the company. Keep in mind, OpenAI is still not profitable, and is expected to continue to burn through billions, at least in the short term.

Overall, I believe that it is still too early to quantify the benefits the recent breakthrough will bring to Microsoft, and there is not enough information to help formulate an expected timeline towards more substantial developments. Although Microsoft CEO stated that, as a result of the development, quantum computing is "years, not decades away", I still believe that at the current stage, the market does not have much to bet on.

I believe that the market is understandably being cautious given how it reacted (or rather, didn't react) to the announcement by Microsoft. However, that being said, I believe many are closely watching for news and developments to surface, which could spark the next wave of optimism. While quantum computing is still in a very early stage, I do not doubt its inevitability. The pivotal moment could come in a few years, which would cause the market to reassess its potential.

Valuation Assessment

MSFT would appear expensive, relative to the wider tech sector, considering its Quant score on valuation of an F. However, the overall Quant score on the stock is 3.47, which technically places it in the hold category.

To determine, whether the stock's pricing is fair considering the value it returns to its shareholders, in terms of growth, I have gone with my usual approach of creating a scatter graph and comparing with peers in the same industry, which in Microsoft's case, is the systems software space.

Author

Using EBITDA forward growth rate and EV/EBITDA, we can see that there is a general trend line among the 21 peers I have selected from the systems software industry. From this, it is apparent that Microsoft, based on its positioning above the line-of-best fit, is actually in the buy zone. Its EV/EBITDA ratio of 21.6, given its forward EBITDA growth rate of 19% is actually quite attractive, relative to the broader relationship seen in the industry.

Based on this alone, which does not factor in future, long-term benefits in the quantum computing space, MSFT stock is actually quite attractively priced.

I recommend a strong buy position on the stock. The benefit is that, despite Microsoft's mammoth size, and $3 trillion market cap, there is substantial growth in the short-term (as demonstrated by its forward EBITDA growth rate) at quite an attractive price.

In addition to this short-term benefit, there is also a potential long-term advantage of exposure to a company that holds a clear advantage in quantum computing hardware with its Majorana chips. While the market boom may still be years away, someone going long on MSFT now could see explosive growth several years down the line, following the steady gains delivered each year before that.

I rate Microsoft as a strong buy.

Risk to Thesis

While I am quite bullish about Microsoft's breakthrough development in quantum computing, I would like to make it very clear that this optimism is mostly built upon speculation, at this point. While it is true that the company's Majorana zero modes give it a major head start against all competitors in this space, it is far too early to anticipate the path forward with this update alone. There is a whole range of technical barriers that researchers still need to overcome before quantum computers become a viable reality. This also, does not factor in the extensive regulatory challenges that companies will likely be faced with as quantum computing pushes closer to real application.

In short, betting on quantum computing, at this early stage (which is even pre-infancy) is a very risky position to hold. Holding it now with the expectation that it will lead to an explosive surge several years down the line may not pay off as smoothly as some would expect.

While this risk is significant, I am very much compelled by the idea of the inevitability of quantum computing and related technology. The introduction of the Majorana zero modes will certainly provide Microsoft with an edge that its competitors lack. Besides, going long on Microsoft, is attractive, even without the quantum element, as I have demonstrated in my valuation section. The stock is in the buy zone, boasting attractive growth despite holding a $3 trillion valuation.

Investor Takeaway

Microsoft's Majorana chips are a true breakthrough in the quantum technologies space, bringing the development of actual quantum computers much closer to the real world, in a practical sense. With quantum computers a reality, the possibilities are truly game-changing, with quantum simulation opening the gateway to new material discovery as well as complex problem-solving that was previously not possible.

While there is no denying that the breakthrough is major news, the market's reaction has been noticeably muted. This makes sense, of course, given that it is still unclear as to how and (more importantly), when Microsoft could benefit from this development.

In my opinion, the risk-reward dynamic is very compelling. Even without accounting for the potential benefits of the Majorana chips over the long-term, Microsoft appears quite attractively priced, given its impressive growth in the short term. Going long on the stock, would be a smart move. In addition to this, there is a benefit of a potentially explosive surge over several years if Microsoft continues playing its quantum computing cards right.

I rate MSFT as a strong buy.