XBox One And Cloud Will Drive Microsoft Future Growth

  • Microsoft stock has gained over 20% in 2014, with investors taking notice of Microsoft’s topline growth and free cash flow growth.
  • Microsoft is well positioned for future growth from its cloud and gaming segments.
  • Fundamentals continue to remain strong and attractive valuations combined with future growth opportunities make Microsoft a good large cap stock to invest in.

Microsoft Xbox One

Looking for a growth play in the large-cap tech space? Look no further than Microsoft (NASDAQ:MSFT). That's right - Microsoft, the tech behemoth whose fate has long been tied to the increasingly irrelevant PC. Things are changing at Microsoft and those changes are starting to translate into positive financial results. Revenue was up nearly 11 percent in 2014, while free cash flow was up nearly nine percent to more than $26 billion. Investors are taking notice, with the company's stock rising nearly 20 percent so far in 2014.

There are a number of reasons for the increase. The company is shifting its focus away from PC-related software and towards cloud computing. It's also starting to see positive cash flow in the XBox division and could see massive growth as China lifts its 13-year-old ban on gaming consoles. Finally, Microsoft has a solid history of paying increasing dividends and the dividend is due for a hike any time now.

Cloud Services Contribute to Microsoft Top Line

Microsoft's Azure cloud offering is firmly entrenched as the number two cloud service for companies, with a 20 percent share of the market. Amazon is number one with more than a 70 percent share.

To gain a larger slice of the pie, Microsoft has instituted an "Amazon price match" on cloud commodities like storage and bandwidth. The move seems to be paying off. Revenue from cloud services like Azure and Office 365 doubled to nearly $4.4 billion in 2014.

That number should grow rapidly in the coming years as the market for cloud services grows and Microsoft wins a larger chunk of the pie. According to Allied Market Research, cloud computing revenue will hit an all-time high of $209.9 billion in 2014. The market is expected to grow by more than 14 percent per year, to $555 billion, by 2020.

Microsoft CEO Satya Nadella has said that the company will continue to focus on the cloud and other services that are device-agnostic.

XBox Turns a Profit

XBox was introduced in 2001 and it's been a consistent loser ever since. In the two-year period of 2006 and 2007, the gaming console lost more than $3 billion by itself. The system is quickly becoming a cash cow for Microsoft, though. The XBox division turned a profit of nearly $900 million in 2014.

While the latest iteration, XBox One, faces stiff competition from Sony's Playstation 4, there is still one very good reason to think that Xbox will have continued success. Earlier this year, China lifted its 13-year-old ban on gaming consoles. The country's leadership has long felt that video games led to moral and intellectual decay. However, with the rise of mobile gaming on cell phones, Chinese officials have realized that they can't restrict gaming forever.

Microsoft has gotten approval to sell five million XBox One units in China in 2014 and they're confident that they'll easily hit that number. To put that in perspective, it took Microsoft nearly six months to sell five million Xbox Ones in the United States after the console was released in November 2013.

Microsoft will be the first console available in China, although Playstation 4 is right behind it. That shouldn't be an issue though as the Chinese gaming market is large enough for multiple console systems to thrive. The country is estimated to have more than 500 million gamers, which is more than the entire United States population. According to PriceWaterhouse Coopers, China has a $10 billion annual gaming market and more than 50 million consoles are expected to be sold there over the next five years.

Microsoft Fundamentals Remain Strong

One of the things that makes Microsoft attractive is that a fundamental analysis shows that its financials remain strong. The growth of its cloud and gaming divisions is simply a bonus on top of a well-established and successful business model. Enterprise software solutions continue to be the company's cash cow.

Investors continue to be drawn to Microsoft because it has consistently returned that cash back to shareholders. It has a yield of 2.5 percent, making it one of the few tech companies that pays a substantial dividend. They've also increased their dividend by an average of 16 percent annually over the past 10 years. It's been nearly a year since the last increase, so another one should be right around the corner.

They've also returned cash to shareholders through buyback programs. In September 2013, the company announced a $40 billion repurchase program. That came on the heels of a previous $40 billion buyback effort.

Microsoft PE ratio chart

Microsoft PE ratio chart

Finally, even with recent growth, the company's PE ratio hovers around 17, relatively low for a growing tech company with a solid dividend. By comparison, Google has a PE of 29. There's still room for investors to look at Microsoft's stock valuation and determine that there's still value there.

Any Microsoft stock analysis should reach a similar conclusion: this tech giant may be entering a second stage of solid and sustained growth.

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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