Microsoft Corporation (MSFT) Stock Is a Buy, Regardless of Earnings

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MSFT - Microsoft Corporation (MSFT) Stock Is a Buy, Regardless of Earnings

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When Microsoft Corporation (NASDAQ:MSFT) reports its fiscal third-quarter results Thursday after the bell, chances are high that the software giant will please investors again and keep MSFT stock heading higher in 2017.

Microsoft Corporation (MSFT) CEO Satya Nadella

Analysts expect the company will grow earnings by more than 40% this year. And even after its expensive LinkedIn acquisition for $26.2 billion, the cloud and software business is creating lots of positive cash flow.

But even if Microsoft manages to stumble in its Q3 report, it’s hard not to like what MSFT has to offer.

The Internet of Things

Microsoft announced a collaboration with Micron Technology, Inc. (NASDAQ:MU) this morning to address internet of things (IoT) security. While Wall Street and Main Street alike are excited about the prospects for interconnected everything — from computers and phones to refrigerators and toasters — security is an increasingly worrisome issue as more devices are plugged into the internet.

Per a press release out today, “The new solution utilizes a hardware ‘root of trust’ integrated into Micron’s flash memory in the IoT device along with the Microsoft Azure IoT cloud to establish a strong trusted link between that IoT device and the cloud.”

Speaking of the cloud …

Hyperscale Cloud

Microsoft appears to have learned from the disadvantages of promoting closed systems. Late last year, the company embraced open standards. As a member of the Open Compute Project, Microsoft’s support for interoperability will accelerate data center hardware development. It also ensures that no matter what hardware supplier is involved — be it Intel Corporation (NASDAQ:INTC) or Advanced Micro Devices, Inc. (NASDAQ:AMD) for processors, the servers will all work together.

MSFT needs the prices for hardware that powers the cloud to fall as fast as possible. Amazon.com, Inc. (NASDAQ:AMZN) is the biggest player with AWS and has 40% of the market share. Microsoft, Alphabet Inc (NASDAQ:GOOGL) and International Business Machines Corp. (NYSE:IBM) have a combined share of around 20%.

Developments on LinkedIn

It’s all too often that people forget about LinkedIn when weighing the prospects for Microsoft stock.

Microsoft has plenty of time and resources to develop LinkedIn’s potential. The professional networking site has no real competition and is the “go-to” site for connecting headhunters with job seekers. LinkedIn is even borrowing an aspect of Stories, except its posts do not disappear.

Facebook Inc (NASDAQ:FB) added disappearing story functions to Instagram and WhatsApp. Snap Inc. (NYSE:SNAP) already offers disappearing stories in the Snapchat app. Conversely, LinkedIn is adding trending storylines to its feed and targeting appropriate readers.

LinkedIn wants its users to spend more time and to come back more often to the site. The newly added feature will also allow the company to more effectively target ads to the right audience.

Microsoft Dynamics Expands

Unable to compete on its own against Salesforce.com, inc. (NYSE:CRM) and Oracle Corporation (NYSE:ORCL), Microsoft partnered up with Adobe Systems Incorporated (NASDAQ:ADBE). By sharing sales and marketing data and the format, the two aim to have an improved CRM and marketing solution that customers will want.

Unfortunately, Salesforce.com’s CRM solution is too good a product to compete against lightly. If Adobe and MSFT mash up their strengths without really figuring out what features would beat Salesforce.com, the partnership will ultimately fail.

Microsoft Surface Might Get Updated

Now set for its fifth iteration, Microsoft may announce the Surface tablet refresh in May. Even if it introduces new hardware, like a Windows-powered Chrome book or Windows Phone, the news further strengthens the importance of Windows 10 in the computing world.

Chances are good, though, that the company will release a Surface 5 computer. MSFT’s Surface 4 Pro was launched in October 2015.

Valuation

Microsoft has a clear earnings growth path, so I would use the 5-year DCF EBITDA (discounted cash flow earnings before interest, tax, depreciation and amortization) Exit model to estimate the fair value of MSFT stock.

Applying a discount rate of between 10.5%-11.5% and assuming revenue grows 5% annually …

Input Projections
Fiscal Years Ending Jun-16 Jun-17 Jun-18 Jun-19 Jun-20 Jun-21
Revenue 85,320 89,586 94,065 98,769 103,707 108,892
% Growth -8.8% 5.0% 5.0% 5.0% 5.0% 5.0%
EBITDA 27,434 29,563 31,982 34,569 34,223 37,023
% of Revenue 32.2% 33.0% 34.0% 35.0% 33.0% 34.0%

Source: finbox.io

This implies a fair value of between $65.88 and $74.27 for MSFT shares:

Low Mid High
Selected Discount Rate 11.5% 11.0% 10.5%
Implied Fair Value $65.88 $70.01 $74.27

Takeaway on MSFT Stock

Microsoft continues to produce strong revenue growth and profits. Its cloud-computing platform is expanding, and the costs to build it are falling. As more companies migrate apps to cloud services, Microsoft’s sales will keep going up.

Meanwhile, MSFT stock still has the support of Microsoft’s legacy businesses and strong cash return to shareholders via dividends and buybacks.

So whether Microsoft scores a beat on Thursday is immaterial. This stock is a buy.

As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.

Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get actionable insight to achieve strong investment returns.


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