In a year in which the S&P 500 has ground sideways, stodgy, old Microsoft (MSFT) — the Big Tech company everyone used to love to hate – has quietly been hitting new 52-week highs and is up nearly 20% year to date.
Sure, that’s nothing compared to Alphabet (GOOGL), which is up by nearly half. But Microsoft stock is beating the pants off of Apple (AAPL), which is barely up 5% in 2015.
Softy is back, and CEO Satya Nadella is steering the company in the right direction with his “mobile first, cloud first” strategy. But with Microsoft shares now trading for 37 times earnings, has the stock price lost touch with reality? After all, this is a company whose iconic product — the Windows operating system — is tied to a declining PC market.
Let’s take a look.
Microsoft Stock by the Numbers
To start, while Microsoft stock’s current price-to-earnings ratio might look a little on the pricey side, that is partly due to the bath it took in its fiscal fourth quarter. Microsoft took a $7.5 billion writedown on its investment in Nokia, which depressed earnings for the quarter and for the entire year. Looking at next year’s expected earnings, Microsoft stock trades at a forward P/E ratio of 20. While that is not “cheap,” per se, it’s in line with the forward P/E of 18 for the S&P 500.
Revenue growth has been disappointing over the past two quarters (looking at a rolling-twelve-month tally), but this is in part due to Microsoft’s transition to a subscription-based model.
For example, Office users traditionally bought a licensed copy in a single one-time payment. But today, Office 365 users pay a low monthly subscription fee. The result is that current revenues appear lower even while the quality of revenues has improved, as a subscription-based model creates regular, recurring payments. Microsoft estimates that this will ultimately bring in 80% more revenue per customer, though it will take time to fully work out.
Microsoft’s decision to give Windows 10 away for free to existing Windows 7 and Windows 8 users has also taken its toll on revenue growth. While probably a smart move in the long run, as it helps to put the Windows 8 debacle in the past, it still takes a bite of out today’s revenues.
PC sales will also probably stage a modest recovery from their current depressed levels as companies replace aging machines.
But the bigger news for Microsoft bulls is that, under Nadella, Microsoft continues to move beyond the Windows platform. Microsoft, along with Alphabet and Amazon (AMZN), is emerging as a leader in cloud services. The cloud-based Azure platform saw its revenues jump 135% last quarter. Revenues from the Intelligent Cloud division, at $5.9 billion last quarter, are quickly catching up to its Productivity and Business Processes division. This unit — which includes Microsoft Office — earned $6.3 billion last quarter.
Though Microsoft stock yields only 2.7% at current prices, it has become something of a favorite among dividend investors due to MSFT’s great track record of raising the dividend. In September, MSFT announced a 16% dividend hike, and the company has grown its dividend at a 19% annual clip over the past three years.
Given that Microsoft has nearly $100 billion in cash and equivalents, I’d say odds are good that growth will continue.
Bottom Line for MSFT Stock
So, what’s the verdict? Is Microsoft stock, despite its run-up, still a buy?
Absolutely.
The risk in owning Microsoft at this point is simply the risk of a broad market sell-off. If that is something that concerns you, consider putting on a stop loss.
But given that Microsoft’s reinvention is still in the early stages, I certainly wouldn’t be in any hurry to sell.
Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long AAPL and MSFT. To read more of his work,
CLICK HERE NOW.
Disclaimers: If I mention a stock favorably, you should assume that I have a position in it, both personally and in client accounts. This does not, however, automatically mean that you should own it. I am expressing my opinions in this newsletter, not offering individualized financial advice or soliciting you to buy securities. See full disclaimer
here.
© 2024 Newsmax Finance. All rights reserved.