With all that cash flow generation, it is little wonder that Microsoft Corporation (NASDAQ:MSFT) is trading at all-time highs and will continue floating higher. MSFT stock is relatively cheap compared to its software peers. And even without any exciting news ahead, shareholders may expect more gains in the coming years.
Microsoft scheduled a Surface tablet announcement for next month. When It was first released, the product was supposed to serve as a template for other suppliers on how to best implement Windows 10 on tablets and notebooks. Instead, Microsoft is enjoying some success in the hardware business.
This is remarkable, because Microsoft has no smartphone on the market that would compete with Apple Inc. (NASDAQ:AAPL) and the iPhone or Alphabet Inc. (NASDAQ:GOOG) and the Pixel 3.
MSFT in Its Element
Microsoft is doing what it does best: innovate the user-experience at the desktop/notebook and tablet market. It gave away Windows 10 for a limited time, to push users to upgrade from Windows 7. Microsoft now has 700 million devices using the Windows 10 operating system.
It now cross-sells its cross-platform software solutions, like Office 365, to mobile and desktop users. The healthy economy may partly explain the success of Office subscription growth but the biggest growth driver is mobile devices. Microsoft owes the double-digit annual growth and 100 million active users to iOS and Android users.
On the enterprise front, Microsoft Teams is another software product growing well, with 200,000 using it, after just 18 months. Dynamics, which previously struggled to gain traction, enjoyed a 61 percent year-on-year user growth on the cloud.
The product may pale in comparison to the uptake of solutions from salesforce.com, inc. (NYSE:CRM). Still, Microsoft only needs to get a few customers in the enterprising choosing Dynamics over salesforce.
This includes Walmart Inc. (NYSE:WMT) and Adobe Systems incorporated (NASDAQ:ADBE). Investors have little care if Dynamics grows well or not because the unit only adds a negligible amount to total sales.
Growing Profits at MSFT
As the company shifts revenue from software sales to monthly subscriptions with success, like Adobe did with Creative Cloud, Microsoft has room to increase its dividends. Profit margins are growing because Microsoft can compete with Amazon’s AWS and Google.
When Microsoft wins customers, it cross-sells its other solutions, like Azure or SQL Server (a database), adding even more to the profit margin growth. The licensing model also has savings for customers.
For example, SQL Server customers who have an on premise solution may add the software on Microsoft’s Azure cloud, at no extra cost. Conversely, a similar set-up on AWS or on Google would have additional licensing costs.
Valuation
Analysts continue to write bullish notes on the stock, albeit the average price target suggests limited upside. Of the 25 analysts covering MSFT stock, 22 have a “buy” call and an average price target of $120.70. This implies upside of only 7%, according to tipranks.
Investors who want to crunch their own numbers may arrive at similar numbers, depending on the financial model that is used. Per finbox.io, a revenue multiples model would give Microsoft stock a fair value in the $80’s.
This model compares the company to other software companies. Conversely, a 5Y DCF EBITDA Exit model would suggest an even higher fair value because it assumes Microsoft will grow at today’s pace for the next five years.
Takeaway
Microsoft is poised for continued growth, which translates to a higher dividend and a higher stock price. Holding the stock forever should pay off for patient investors.
Disclosure: The author does not own shares in any of the companies mentioned.
