I’ve been rather bearish on Microsoft Corporation (NASDAQ:MSFT) for some time now. Admittedly, I’ve so far been wrong, with MSFT stock up 18% this year, even after a recent pullback.
And, I’ll admit, as we approach the end of September, I’ve become incrementally more positive on MSFT stock. Sure, I still disagree with the idea that this ‘isn’t your father’s Microsoft’, as some bulls argue. The Redmond, Wash. tech behemoth’s persistent second- (or third-) place problem outside of legacy PC businesses remains a concern.
Still, Microsoft continues to make progress adapting to the new age of tech. Fears earlier this decade that the once-giant-software maker would be the next International Business Machines Corp. (NYSE:IBM) — a former titan left behind by more nimble upstarts — have proven to be unfounded. MSFT is showing strength in cloud. It’s showing potential in future growth centers like virtual reality and quantum computing. At worst, it’s a company that still looks innovative — and even somewhat nimble itself.
I continue to believe that a lot of that growth already is priced into MSFT stock. But with shares coming back toward $70, and some intriguing announcements coming out of the company’s Ignite conference this week, even this MSFT bear is starting to get intrigued.
Microsoft Corporation And The Cloud
MSFT stock bulls routinely point to the company’s cloud presence. Azure cloud platform revenues doubled in fiscal 2017, according to the MSFT 10-K. While the platform still lags Amazon.com, Inc. (NASDAQ:AMZN) Web Services, Azure is closing the gap. And even a solid second-place position, ahead of other rivals like Oracle Corporation (NYSE:ORCL) and Alphabet Inc (NASDAQ:GOOGL) seems enough to drive optimism toward MSFT stock.
To be sure, I’ve been more skeptical than most of Microsoft’s cloud potential. The move of Office, for instance, to Office 365 isn’t a huge change for the company, at least relative to a $560 billion market capitalization. It’s not as if 365 revenue is “new” — it’s simply a shift in billing. Similarly, Azure has the potential to cannibalize its profitable SQL Server product line.
But Microsoft seems to be reacting well to these potential issues. Releases of SQL Server for Linux, data migration tools, and Azure Stack have been described as “long-anticipated secret weapons” in the battle for cloud supremacy.
More broadly, they show a Microsoft willing to work in a more open system — and meet the needs of developers and IT professionals. As the overall strategy continues to progress, it increasingly looks like the company is cementing an important role in the future of the cloud. That wasn’t a certainty just a few years ago; even as a bear on the shares, I have to admit the improvements justify much of the run-up in MSFT stock over the past few years.
Aces In The Hole
There are some other intriguing moves as well. Microsoft is offering specialized versions of its software, across Windows, Office and the Dynamics CRM platform. The company is still is LinkedIn.
Meanwhile, the company is getting ahead of the potential revolution in quantum computing. And, as my InvestorPlace colleague Tom Taulli pointed out earlier this month, Microsoft looks very well-positioned in artificial intelligence.
I still see a concern that the nearly half of revenue coming from the PC will hurt Microsoft’s long-term growth prospects. And none of these initiatives, on their own, seem likely to move MSFT stock, at least not in the next two years.
But the broad sense increasingly is that Microsoft Corporation has a strategy that makes sense, and one that it is executing. It certainly isn’t falling behind. It isn’t ceding cloud to newer rivals. It hasn’t let Windows or Office go the way of the company’s former dominance in search. Given that MSFT stock isn’t that expensive, that might be enough to support the current valuation.
MSFT Stock Is (Kind Of) Cheap
It’s not as if MSFT stock is priced for all that much growth. Backing out the company’s $7+ per share in net cash, the stock trades at under 21x FY18 analyst estimates. That’s despite what should be high-single-digit growth, backing out a large one-time tax benefit booked in the company’s fourth quarter.
With Microsoft having just boosted its dividend, MSFT stock now yields 2.3% — more than a 10-year US Treasury bond. And given that the company should be able to grow, there’s hope for additional capital appreciation as well.
I’m still a bit skeptical as to how much upside is left in MSFT stock; the consensus target is just above 9%. I wonder how much growth the company can drive if the PC cycle takes another leg down. But CEO Satya Nadella has done a fine job. And even a Microsoft bear like me has to admit that the company looks much better-positioned for the future than it did just a couple of years ago.
As of this writing, Vince Martin has no positions in any of the aforementioned securities.
