Just when I thought that Microsoft Corporation (NASDAQ:MSFT) might become obsolete — a few years ago, anyway — it launched several new initiatives. I knew that these would either make or break MSFT stock. If the former, then the Satya Nadella era would likely mean there was an actual vision to execute upon.
That appears to be the case. Microsoft stock appears to be a bona fide growth stock once again. The latest MSFT earnings were outstanding.
Revenue was up 12% to $24.5 billion. Operating income was up 15% to $7.7 billion, and net income was up 16% to $6.6 billion. Diluted EPS was up 17% to $0.84 per share. I consider 15% growth to be the threshold for what constitutes a “growth stock,” give or take.
As we dive into specific numbers, the metrics are truly impressive all the way through. Let’s look at each segment.
I’m pretty blown away, to be honest, about the Productivity and Business Processes segment. Revenue exploded 28% to $8.2 billion. What’s interesting to me is that the office commercial products and cloud services saw a 10% increase, and the consumer side was up 12%. That is good, solid, reliable growth. That’s what provides some of the core cash flow for MSFT stock.
But the Dynamics 365 product just went nuts, with growth up 69%. Clearly, this has the potential to be enormous for Microsoft stock.
The Intelligent Cloud segment has been closely watched for the Azure product. It’s doing great, with revenue up a whopping 90%. That contributed to the sub-segment growth in server products and cloud services, bringing the entire sub-segment to an increase of 17%. Unsurprisingly, Enterprise Services was essential flat, as this product has matured.
Nobody will be impressed by the fact that the Personal Computing segment was flat. However, what’s critical about it, is that revenue was $9.4 billion. That is also a core contributor to operating cash flow. It is this cash flow that allows MSFT stock to continue to grow and fund operations and the MSFT dividend.
Free cash flow was $8.7 billion this quarter, up from $8.15 billion last year, by the way.
Also interesting about this segment is that search advertising revenue was up 15%. Surface revenue continues to grow — up 12% — which was a bit of a surprise to me. MSFT may also be on to something with its Xbox services revenue segment, which was up 21%. I think Xbox may just turn out to be a vertically integrated platform that encompasses all kinds of entertainment going forward.
Microsoft has the extraordinary advantage of having $138 billion in cash, provided Nadella continues to execute on and expand the company’s vision. That’s almost $18 per share in cash. Now, that is offset by $76 billion in debt that costs next to nothing. The point is that MSFT stock can keep heading higher because that cash can do anything.
However, there must be a vision for “anything” to actually happen.
Bottom Line on MSFT Stock
Now, if we back out the net cash position of $62 billion, or about $8 per share, then we get a stock price of about $73. That means MSFT stock trades at about 26x TTM net income. Analysts peg five-year annualized growth at 11%. I add the dividend yield of 2.13%, then 10% premiums for each of the following: outstanding cash flow, great cash position, and world-class brand name. That brings the total fair value to about 17x.
A company growing earnings at 15% or higher usually means that I’ll grant that stock a PEG ratio of up to 2.0, from the normal base of 1.0. Microsoft kind of straddles the line here a bit. It has a PEG ratio of 1.55. I think that given its fantastic cash position and that it is executing on its new strategy, I would suggest a buy on MSFT stock if you plan to hold for the very long term.
Lawrence Meyers is the CEO of PDL Capital and manager of the forthcoming Liberty Portfolio stock newsletter. He has no position in any stocks mentioned. He has 22 years’ experience in the stock market and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
