Microsoft Corporation (NASDAQ:MSFT) and, by extension, MSFT stock have been one of the best turnaround stories over the past five years and, in particular, since CEO Satya Nadella took over software giant from then CEO Steve Ballmer.
Microsoft stock holders have gotten rich from the company’s successful push towards the cloud with its cloud-services product, Azure, which competes strongly with Amazon.com, Inc.’s (NASDAQ:AMZN) market-leading Amazon Web Services (AWS) platform.
But with MSFT stock climbing nearly 25% over the past year and 60% in three years, it’s reasonable to ask: How much better can things get?
Is Microsoft’s Cloud Transition Over?
Strong execution and demand for its cloud-based services has helped Microsoft stock outperform the S&P 500 Index on a year-to-date basis. While the company has gained nearly 17% this year, the S&P 500 has risen 9%.
Wall Street loves the fact that Microsoft is no longer tied to the fledgling PC industry as evidenced by the fact that for the first time, in the fourth-quarter Office 365 Commercial revenue outgrew and surpassed revenues from Microsoft’s traditional licensing business.
During the fourth quarter, Microsoft’s Commercial business, which encompasses products such as Office 365 and related cloud services revenue, rose 5% year-over-year. Notably, Office 365 commercial revenue surged 43%, while Office 365 posted a 35% YOY rise in commercial seat growth. The strong cloud performance helped MSFT achieved a 42% YOY rise in fourth-quarter earnings-per-share of $98 cents per share, which not only rose 34% YOY, but also crushed Street estimates by 27 cents.
Fourth-quarter revenues, meanwhile, rose 9% YOY $24.70 billion, topping estimates by more than $400 million. Full-year revenue of $96.66 billion in fiscal 2017 grew 5% YOY. But the main story here for MSFT stock was the fiscal 2017 performance of the commercial cloud business, which ended the year at an annualized rate of $15 billion.
It’s now fair to ask, has Microsoft fully transitioned towards the cloud? And if so, has that transition already fully priced into MSFT stock?
Can MSFT Catch Amazon?
Despite the strong rate of growth Microsoft has demonstrated, the company still trails Amazon’s AWS, which in the second quarter, garnered 41% of the global market for public cloud services, according to Synergy Research Group. This compares to 13% share for Microsoft, while Google subsidiary Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) had a 7% share with International Business Machines Corp. (NYSE:IBM) logging 5%.
While some analysts expect AWS to maintain a healthy growth rate of 25% to 35% over the next five years, Evercore analyst Kirk Materne expects MSFT’s Azure to grow at around 70% to 80% in fiscal year 2018.
“While [Amazon Web Services] remains the clear leader in terms of public cloud computing today, one of the most notable takeaways from our meetings was the improving position of Azure, both as it relates to product maturity and market presence,” Materne said in a recent note to investors, citing new Azure features such as speech recognition and other tools, which he says brings Azure closer to Amazon’s AWS.
But Microsoft CEO Nadella, who recently unveiled a major business reorganization, aimed at boosting the company’s cloud position, no longer wants to play second fiddle to Amazon, which is growing AWS revenue at over 42%. And Materne sees Microsoft’s new business re-organization as having a boosting effect on the company’s ability to catch Amazon.
“We believe the fact that Microsoft is now incentivizing its field organization to focus on the amount of Azure consumed is also creating more focus on driving customer success on Azure, and this is resulting in a growing pipeline and greater understanding of Azure’s capabilities,” Materne wrote.
Bottom Line for MSFT Stock
Looking ahead, Microsoft will report first-quarter fiscal 2018 earnings results on Oct. 30. Wall Street expects the company to earn 76 cents per share on revenue of $23.94 billion, translating to flat EPS growth, while revenue is expected to rise 7.2%.
Based on fiscal 2018 estimates of $3.21 per share, MSFT stock is priced at 22 times earnings. While this means MSFT stock is no bargain, compared to the forward price-to-earnings ratio of 19 for the S&P 500 Index, these shares deserve a higher multiple if the company is valued on its cloud-first strategy.
And with worldwide spending on cloud computing services expected to grow to $195 billion by 2020, according to technology market research firm IDC, Microsoft — the world’s largest software company, which also pays a solid annual dividend yield of 2.15% — is showing no signs of slowing down.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.