- Microsoft's latest earnings report was impressive. Its network effect and switching costs protect this stock from the downside.
- Azure continues to grow from strength to strength. Expect margins to expand in 2017.
- Microsoft's legacy divisions are holding up exceptionally well despite poor global PC shipments at present.
Microsoft Corporation (NASDAQ:MSFT) remains very close to $60 a share (all time highs) and analysts are debating whether the stock can stay at this valuation. Currently, it has an earnings multiple of 29, which is almost double the company's 5-year average and 12 points higher than the 10 year average of 17.6. The company's impressive fiscal Q1 2017 earnings drove the stock price higher on the 21st of October. Azure growth was again at the forefront as the company reported both top and bottom line increases by almost $600 million and $0.08 in EPS respectively. Yet, you should wait for pullbacks to buy MSFT stock. Here's why.
Microsoft stock is now up almost 10% year to date, but it hasn't been all smooth sailing for Microsoft this year. In fact, MSFT stock went under $50 when equities, in general, were putting in an intermediate cycle low in February. Furthermore, the Brexit event resulted in Microsoft stock dropping to around $48 a share in July. Therefore, it is fair to say that this stock is definitely more volatile than the S&P 500 (INDX:SPAL) and would decline more if equity markets were to suffer a meaningful decline. That said, I like Microsoft stock from a long-term perspective, and think the stock could easily give back at least 10% before resetting sentiment, to go higher once more. (See also: Microsoft Corporation: This Could Drive MSFT Stock Way Higher)
"Azure" Brings A Solid Competitive Advantage To The Table
The biggest reason to go long MSFT stock for the long term is its competitive advantages. The network effect of its operating systems and software results in high switching costs, which build customer loyalty over time. This was evident in its latest quarter with its productivity segment, which grew its revenues by 8% to $6.7 billion. Investors should remember that many cloud versions of "Office" were copied before Microsoft launched its own format. Nevertheless, competitors just couldn't steal market share due to the strong competitive advantages Microsoft holds in this part of its business. As a result, I was not surprised to see Office 365 grow its subscriber base by 50%+, to now reach 24 million subscribers.
Selling Its Cloud Offerings to Corporates Has Given The Company A New Lease Of Life
The CEO's decision to move Microsoft into the corporate sector through its cloud products has proven to be a masterstroke. Revenue from Azure grew by a whopping 116% and this is where I feel the downside risk in Microsoft's share price is negated to a large degree. Microsoft has a big advantage here over fellow cloud producers in the sense that Azure hosts all of the company's flagship products. Therefore, business customers can sign up for the storage and computing power of Azure as well as all of the software that is already uploaded on the cloud. Moreover, it's hybrid model is where Microsoft can gain a lot of market share in the near-term. Why? Because although I foresee companies using public clouds on mass in the future, many of them at present are looking for a hybrid option where they can combine their own IT with third-party clouds to manage workloads. This is where Microsoft's offering comes into its own. This is also the reason why Amazon.com (NASDAQ:AMZN) recently signed a deal with Vmware (NYSE:VMW) in order to compete head on with Microsoft in the hybrid arena.
Increasing Margins alongside Sustained Heavy Investment In Data Centers Is A Good Sign
When you combine the huge investment Microsoft is currently ploughing into the cloud, you are looking at a company that will have far higher margins and far higher levels of passive income in the near future. In fact, gross margins for the commercial cloud are expected to continue their upward course ( hitting 49% in the first quarter of this year). The good thing about Microsoft's cloud is that it appears to be well equipped to offset any potential declines in the company's Legacy divisions. (See also: Microsoft Corporation (MSFT) Stock Could Hit $80 On Strong Fundamentals)
PC Division Is Holding Up Very Well Despite Sluggish Global PC Shipments
Speaking of the company's MPC ( More Personal Computing) division, Microsoft reported a 2% drop in its revenues, which came in at $9.3 billion. This division makes up the lion's share of Microsoft's revenues but taking into account the current trend of PC shipments, this division is holding up exceptionally well. On the business side of this division, sales only dropped fractionally, which illustrates to me again the stickiness of products such as Windows 10, etc.
Short Term - A Pullback May Be On The Cards For MSFT Stock
The September lows have been broken twice in October which illustrates to me that the S&P500 will end up going lower. Microsoft's share price in all probability will lose more than the market, so $52-$55 should be one's target.
Microsoft stock price will probably pull back in the near-term after a very impressive first quarter earnings report. However, I feel that a pullback will be a good buying opportunity, as its cloud offerings continue to grow from strength to strength. Microsoft stock remains an excellent stable dividend stock due to strong fundamentals and an exceptionally strong balance sheet.
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