I am highly bullish Microsoft (MSFT). The main argument from bearish investors is that its trailing valuation makes Microsoft appear overpriced. However, I disagree with this take.
Sure, Microsoft was cheaper in the past than it is today. However, that shallow analysis gives no value to the fact that Microsoft has successfully repositioned itself to be at forefront of the modern workplace. I argue that Microsoft is a well diversified, highly cash generative company which is still undervalued.
Q1 2019 Results
Before we get stuck in, I would briefly note that the past several weeks have been a fabulous time to be a value investor. The market has become fairly discerning over growth for growth's sake, compared with profitable and sensible growth.
Microsoft kicked off Q1 with a smash. Revenue was up 18% (const. currency), and strong cost controls allowed Microsoft's operating income to soar to 28% (const. currency), which led to a remarkable EPS growth of 33% YoY to $1.12 (const. currency).
Azure – Solidifying The Opportunity
No customer wants to be dependent on a provider that sells them technology on one end and competes with them on the other.
– CEO Nadella
In this subtle sentence, Microsoft is giving Amazon (AMZN) a little jab. Here, Nadella is essentially saying to all enterprises feeling squeezed by Amazon, come with Azure. Azure has the technology, and we are aligned with you, to succeed.
Amazon succeeded for a long time in leading the cloud war. But those days are now over. And what makes Microsoft's intelligent cloud so appealing is that Microsoft's platform spans a comprehensive product suite. Enterprises which are familiar with Microsoft Office packages can seamlessly send data between the cloud and the edge.
Moreover, Azure has from inception being truly focused on confidentiality and integrity of data. Further, I trust that there are few cloud providers which are able to supply smaller enterprises equally as well as large commercial enterprises, such as Volkswagen (OTCPK:VWAGY).
Furthermore, the advantage which Microsoft has built up compared with other peers, such as IBM (IBM) is that Microsoft has continuously kept its eye on the ball and developed a solid back office AI platform to assist companies in unlocking insights from their own data in an effort to improve their productivity.
Strong Innovation And Diversification
The modern workplace is becoming increasingly digitalized. Businesses need users to be integrated with their data. And while Microsoft could easily rest on its laurels of business, this is not the avenue it chooses to take.
Its acquisition of GitHub goes a long way to prove that innovation is still part of Microsoft's core ethos. In fact, if GitHub turns out to be even half as successful as Microsoft's acquisition of LinkedIn (up 33% in the quarter to $382 million) shareholders will find themselves nicely rewarded.
Having said that, the main reason why I believe Microsoft offers investors a strong opportunity for a satisfactory return is stemmed from its portfolio of businesses, see below.
Source: author's calculations; Q1 2019 results
Microsoft's bottom line is nicely diversified. Even if one of Microsoft's revenue streams, such as Windows becomes a laggard (revenue up 6% in Q1 2019 and integral part of More Personal Computing segment), the other segments help to smooth out Microsoft's results.
Readers will no doubt know that the one thing investors crave from their stock investments is stability and predictability. A company which is able to offer the market what it craves will ultimately get rewarded with a higher multiple.
Here is a quick question: if the market was to contract tomorrow, would you prefer to have your investments in companies with weak balance sheets, or strong? This answers itself. Buffett teaches us time and time again that the best way to compound our returns is not to lose capital.
Personally, I would much rather be invested in a company which is growing at solid double digits YoY with nearly $60 billion of net cash, than being invested in something which is barely profitable, such as Amazon, even if the latter largely competes in the same cloud space, is exposed to the same tailwinds, and has a large share of the same market (for now).
Source: author's calculations, morningstar.com
I have already touched upon this several times in the article. Price matters. Investors are presently asked to pay up less than 18 times on P/Cash Flow (from operations; GAAP) for Microsoft.
Moreover, the icing on the cake for shareholders is that shockingly, this mature business's GAAP operating margins are trending higher than at any point in the past 5 years.
And a final question: in the event of a recession tomorrow, will enterprises still use Microsoft's products? Yes, absolutely. Microsoft is practically recession-proof.
Shareholders have several ways to win with Microsoft. Through its solid growth opportunity with Azure. Through its diversified portfolio of business. But my personal favorite, an attractive valuation.
Author's note: The only favor I ask is that you click the “Follow” button so I can grow my Seeking Alpha friendships and our Deep Value network.
Disclaimer: Please do your own due diligence to reach your own conclusions.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.