This household-name software provider recently surpassed Apple as the world’s most valuable company based on market cap. It continues to expand in the fast-growing field of cloud-computing with a lucrative subscription model featuring high renewal rates.
Although the stock has gained over 20% in the past year, further gains should lie ahead based on the company’s strategic acquisition strategy, continued R&D investment, and a strong balance sheet backed by an aggressive stock buyback program.
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MICROSOFT CORP. $104(Nasdaq symbol MSFT; www.microsoft.com)began operating in 1975 and is now the world’s largest computer software company.
Its Windows operating system powers about 90% of the world’s personal computers. Microsoft’s other main product—its Office suite, which includes a word processor (Word), spreadsheets (Excel) and slide presentations (PowerPoint)—controls over half of its market.
The company continues to benefit from its 2014 decision to shift to cloud-computing services: instead of buying its software as a one-time purchase, clients now access that software online through subscription plans. They can also store data files using remote servers.
The company’s main cloud service is Microsoft Azure. It lets individuals and businesses manage databases as well as store and back up their files. Users can run Azure on a wide variety of devices, including smartphones and tablets.
Microsoft also spurs its growth through strategic acquisitions. In December 2016, it paid $27.0 billion for LinkedIn, the world’s largest online professional network. LinkedIn’s 450 million members can create, manage and share their career details and connect with other members through the firm’s website and mobile apps.
In October 2018, the company paid $7.5 billion in stock for GitHub, which operates a website that lets computer programmers share code and collaborate on software projects. It currently has over 28 million users.
Growth Stocks: Earnings are up 14.2% as revenue rises across all businesses
GitHub should help Microsoft improve the performance of its software on non-Windows devices. For example, the company continues to rebuild its Edge Internet browser software using Google’s open-source Chromium software. That should make websites load more quickly.
In addition to its cloud-computing products, Microsoft continues to expand its computer-hardware products. Those include its Xbox video game console and Surface tablet computer. Microsoft also recently launched a new line of premium headphones under the Surface brand. That will help it compete with Apple’s popular Beats headphones.
The company’s revenue rose 7.8%, from $86.8 billion in 2014 to $93.6 billion in 2015 (fiscal years end June 30). Microsoft gets just over half of its revenue from customers outside of the U.S., and the higher U.S. dollar cut its revenue in 2016 to $92.0 billion. However, revenue in 2017 rebounded 5.1% to $96.7 billion. It rose a further 14.2% in 2018, to $110.4 billion.
Earnings fell 0.9%, from $22.1 billion in 2014 to $21.9 billion in 2015. Microsoft is an aggressive buyer of its own shares, so per-share earnings rose 0.8%, from $2.63 to $2.65. Earnings then rose to $2.79 a share (or $22.3 billion) in 2016, and reached $3.88 a share (or $30.3 billion) in 2018.
In the quarter ended September 30, 2018, overall revenue rose 18.5%, to $29.1 billion from $24.5 billion a year earlier.
Revenue rose for all three of its businesses: More Personal Computing (37% of the total) gained 14.6% on strong sales of Xbox and Surface products; the Productivity and Business Processes unit (34%) saw revenue rise 18.6% on higher demand for Microsoft Office and LinkedIn products; and the Intelligent Cloud (29%) unit reported 23.8% higher revenue due to a 76% revenue jump for the Azure cloud business.
Overall higher revenue helped spur Microsoft’s earnings in the quarter to $8.8 billion. That’s up 34.2% from $6.6 billion a year earlier. Per-share earnings gained 35.7%, to $1.14 from $0.84, on fewer shares outstanding.
Strong commitment to research a hidden asset
Microsoft’s research costs rose 11.3% in the latest quarter, to $4.0 billion (or 13.7% of its revenue) from $3.6 billion (14.6%) a year earlier. Since the company must write off those costs immediately, it’s more profitable than it seems.
Part of that spending is going toward adding artificial intelligence (AI) features to its Azure services. AI should make it easier for Azure to recognize images and understand spoken languages, which should up speed up its overall performance. Those improvements will help Azure compete with cloud services from Amazon.com and Google.
The company’s strong balance sheet will continue to support those investments. As of September 30, 2018, it held cash of $135.9 billion, or $17.69 a share. Its long-term debt of $69.7 billion is a low 9% of its market cap.
Long history of rising dividends
Microsoft began paying regular dividends in 2004 and has increased that rate each year since 2010. Starting with the December 2018 payment, the company raised its quarterly dividend by 9.5%, to $0.46 a share from $0.42. The new annual rate of $1.84 yields 1.8%.
The company is also an active buyer of its own shares. It still has $25.6 billion remaining under its current buyback authorization. There are no time limits for those share purchases.
Microsoft trades at 23.4 times the $4.44 a share it should earn in fiscal 2019. That’s a reasonable multiple in light of its fast-growing cloud business.
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