Old-line tech operators like IBM (IBM), EMC (EMC) and Oracle (ORCL) have been having a tough time lately. But there is one that has bucked the trend: Microsoft (MSFT).
As seen with the company’s latest earnings report, Microsoft is finding ways to evolve with the dynamic changes, such as cloud computing. The result is that Microsoft stock has turned into a top performer. For the past year, the return is a sizzling 35%.
Yet there are still some nagging issues. The PC market remain sluggish, and Microsoft’s efforts in mobile have proved to been mostly a bust.
So is MSFT still a good buy here? Or should investors hold off? Let’s take a look at the pros and cons of Microsoft Stock:
Microsoft Stock Pros
Hybrid Cloud: Despite all the hype, many companies don’t actually want cloud-only solutions. Rather, they prefer a blend of on-premise software as well as connected services. And that’s where Microsoft has been focusing. In fiscal Q1, revenues in the commercial cloud division soared by 128% to $1.18 billion. A key part of the success was the Azure platform, which allows for seamless use of traditional software, like SQL databases, as well as cloud systems like Office 365, Microsoft Dynamics and even Skype. Microsoft hybrid cloud is certainly unique and will likely continue to get lots of traction.
Gaming: The Xbox posted a strong performance in fiscal Q1, with a 102% jump in unit sales to 2.4 million (including Xbox One and Xbox 360 models). To help boost things, Microsoft has pulled off key acquisitions, such as Mojang and Minecraft. At the same time, the company has exclusive titles like Halo and the upcoming Sunset Overdrive, which help maintain customer loyalty. While gaming can be a volatile business, Microsoft is still in the early stages for its new console platform. Besides, the upcoming Christmas season should help to keep up the sales momentum.
Financials: There’s not much here to complain about. In the fiscal first quarter, revenues increased by 25% to $23.2 billion and earnings came to 54 cents per share. While the earnings dropped by 13%, this was mainly from a $1.14 billion restructuring charge for the Nokia acquisition. Excluding this, MSFT earned 65 cents per share. What to do with the strong cash flows? MSFT will probably continue to aggressively buyback shares and pay dividends. In latest quarter, the company increased buybacks and dividends by 19%.
Microsoft Stock Cons
Mobile: MSFT whiffed on mobile. For the most part, the competitive environment remains intense, especially given huge iPhone launch from Apple (AAPL). It’s true that the Surface tablet is showing some promise, with sales spiking from $400 million to $900 million. Yet this is still a tiny amount of the overall market. The irony is that the most successful part of the Microsoft mobile strategy is its intellectual property. Keep in mind that the company generates substantial amounts for licensing its patents for Android devices, such as to Samsung.
PCs: The PC market remains in secular decline. A report from IDC indicated a 1.7% decline in PC shipments in the most recent quarter. For MSFT, this is definitely a big problem. because the company’s highly profitable Windows platform is heavily dependent on PCs. This is why the company is currently revamping the operating system to allow it to work better on mobile devices.
IT Spending. Enterprise IT spending has been mostly soft — and the situation could get worse. Europe looks vulnerable for another recession, and Russia is feeling the pressure from U.S. sanctions as well as plunging oil prices. Oh, and China is decelerating. All in all, IT spending is generally sensitive to macroeconomic trends because companies can easily delay capital expenditures. So if things get worse with global growth, expect Microsoft stock to feel the pressure.
Verdict on Microsoft Stock
Since taking the helm at Microsoft in February, Satya Nadella has shown that he knows how to find growth opportunities. A key is that he has a strong vision: to build a productivity and platform company for the mobile-first, cloud-first world.
Granted, the mobile part is still lacking. But the cloud is running on all cylinders. It certainly helps that the company has a unique approach that meets the needs of customers.
OK, then what about the valuation on MSFT stock? It is getting pricier — but it is still reasonable. The forward price-to-earnings ratio is 14, which compares to 17 for SAP (SAP), 11 for Oracle and 13 for EMC.
So then should you buy MSFT stock? Yes — the company should benefit from the growth in cloud computing and should get a nice short-term boost from holiday Xbox sales.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
