Microsoft (MSFT – Get Report) has been an incredibly rewarding stock to own in 2019, up 35% versus the S&P500 (SPY – Get Report) which is up 19%. With Q1 2020 earnings out this Wednesday, what should investors think about?
Microsoft is well-diversified, with all three business units delivering shareholders with growth and strong returns on invested capital.
Notwithstanding its size, as well as being a household name for decades, it is still not priced for perfection. Readers would do well to add on any weakness in its share price and take a long-term view on its shares.
Microsoft finished fiscal 2019 in remarkable shape. Its revenues were up 14% year-over-year (in constant currency). Meanwhile, what particularly delighted investors was its bottom line non-GAAP EPS number of $1.37, which beat consensus estimates by $0.16 — what’s not to like?
Analysts had been promoting Microsoft as a cloud story and talking up Azure. Thus, when Azure’s growth appeared to be slowing down, Wall Street analysts were taken aback.
However, not only is Azure still growing at north of 60% year-over-year (currency-adjusted), this is largely clean organic growth. Contrast that with IBM’s (IBM – Get Report) 14% cloud growth (adjusted for currency and divestments), which was boosted by its Red Hat acquisition. Looking back to Microsoft Azure’s, this growth does not appear so terrible, does it?
Another thing Microsoft has going for it is its incredible diversification. Each one of its segments generates close to a third of total revenue. Digging deeper we can see that certain segments have slightly better margins, such as its Productivity and Business Processes (Office Packages and LinkedIn).
Having said that, I believe the mistake too many analysts and investors make on Microsoft is to attempt to dissect where growth is coming from next quarter, rather than taking a step back and thinking about Microsoft holistically. Microsoft is one of the strongest cash-generative companies ever. Period.
Financial Position Is Rock Solid
Not only does Microsoft boast operating margins north of 35%, but it has one of the strongest moats of any company. Further, Microsoft has proven beyond any doubt, that under CEO Satya Nadella, it has what it takes to remain relevant into the future. Also, equally important, Microsoft has proven itself to be a remarkable steward of capital.
Specifically, Microsoft ended fiscal 2019 with a net cash position of $61 billion. And given its consistent flow of free cash, Microsoft not only raised its quarterly dividend by 11% to $0.51, but it announced a fresh $40 billion share repurchase program amounting to approximately 4% of its total market cap.
Valuation – Paying Up For Quality
Microsoft is one of the biggest companies in the world, as well as one of the most followed stocks, with a product which we all run into at some point throughout our week (if not daily). Consequently, investors are not likely to see it trading particularly cheaply.
The table above illustrates this sentiment. Microsoft’s cash flows from operations are being priced at approximately 20x, which for a company expected to grow at 10%-12% for the foreseeable future, does not scream bargain opportunity.
However, it should be noted that Microsoft has a minimal need for capital expenditure requirements. In addition, compared with Amazon (AMZN – Get Report) , which competes with Microsoft in the cloud, Microsoft’s balance sheet is substantially better. And compared to Apple (AAPL – Get Report) , not only are Microsoft’s operations better diversified and not contingent on one key product, but Microsoft is still posting double-digit revenue growth rates.
The Bottom Line
Microsoft announces its highly-anticipated Q1 2020 results this Wednesday night after hours. This is a fantastic, well-managed company with strong secular tailwinds at its back.
Investors should certainly consider Microsoft as part of any well-diversified portfolio.
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