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Wed, September 30 at 4:00PM ET

BMW Deal Highlights the Bull Case for Microsoft Stock

But the valuation of MSFT stock makes its outlook mixed

The gains of Microsoft (NASDAQ:MSFT) stock truly have been astounding. As recently as 2013, Microsoft stock traded under $30. Since then, MSFT stock has quadrupled. It now trades at all-time highs, after adding well over $600 billion of market value.

microsoft stock MSFT stock
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Obviously, there are a number of reasons for the huge gains. But the most important has been Microsoft’s reduced reliance on PCs. Indeed, the valuation assigned to Microsoft stock earlier this decade wasn’t necessarily unfair or even wrong.

The smartphone revolution was expected to lead to stagnant growth of desktops and laptops, which turned out to be the case. Microsoft’s effort to enter the smartphone market – via an acquisition of the hardware division of Nokia (NYSE:NOK) – was a disaster. A $7.2 billion investment was worth only $350 million after barely two years.

MSFT stock simply was priced for zero growth, and it delivered on those expectations. Between fiscal 2012 and fiscal 2016, Microsoft’s adjusted net income actually declined.

Since then, the company’s shift away from PCs has driven growth  and increased investors’ optimism towards Microsoft stock. Microsoft’s earnings have grown, and investors now are willing to pay twice as much for those earnings as they did just a few years ago. For the valuation of MSFT stock to remain at that level, the company’s shift away from PCs has to continue, and a recent deal shows how that might happen.

The Microsoft-BMW Deal

This week, BMW (OTCMKTS:BMWYY) and MSFT announced a new program called the Open Manufacturing Platform or OMP. The program aims to make manufacturing more like tech, as TechCrunch noted. In tech, accepted standards  or widely used platforms  allow for interoperability between manufacturers, customers, and other market participants. The proprietary nature of manufacturing systems, however, creates much more friction among various entities.

BMW and Microsoft are looking to recruit other partners to the venture, according to TechCrunch, In 2019, the companies hope to recruit four to six new partners. It’s a Herculean task, and one that is unlikely to drive near-term earnings growth or even show results any time soon.

But it does represent yet another step for MSFT away from the PC and towards the cloud and IoT (Internet of Things) offerings that will drive increased growth. The OMP will be based on Microsoft’s industrial IoT offering and could boost the latter’s growth. Given that the platform is part of Microsoft’s Azure offering – a huge contributor to the recent re-valuation of MSFT stock – the deal will be another long-term driver of MSFT stock.

The PC Shift and MSFT Stock

The question at the moment is whether MSFT has sufficiently shifted away from PCs. For all the optimism toward Microsoft stock in recent years, PCs remain a huge part of its business. In fiscal 2018, according to its 10-K, PCs still drove nearly 40% of revenue  and 30% of its operating profit.

But its PC business is growing. Perhaps stunningly, the unit’s operating profit rose 71% in two years, and another 20% in the first half of fiscal 2019. The Surface line of hardware appears to be a key factor in that growth.

Still, the PC business should start to slow down, particularly as the benefits of the shift to cloud-based subscriptions slow. PC unit growth was negative in 2018 for the seventh consecutive year. Consumer demand, in particular, remains weak, even though the economy is strong.

Is Microsoft Stock Overpriced?

And so any investor buying (or owning) MSFT stock at the moment has to trust in the cloud shift. Certainly, the company’s recent results, and its innovative efforts like the deal with BMW, suggest that investors should be upbeat about the shift. Still, outside of PCs, Microsoft is battling other giants, ranging from Amazon.com (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOGL,GOOG) in the cloud to Salesforce.com (NYSE:CRM) in CRM software.

To own MSFT stock at this point, when Microsoft stock is trading at 24 times the consensus forward EPS  for MSFT,  an investor has to have tremendous confidence that it can succeed in areas other than PCs. And I’m still not quite convinced on that front.

I recommended Microsoft stock back in November, but it was cheaper then. Back near its highs, MSFT probably can grind out continued positive returns,  but it probably won’t outperform the market by much, if at all.

But other investors might see the outlook of Microsoft stock differently. And the BMW deal shows why that’s the case. If Microsoft can continue to grow outside of PCs – and continue to position itself as a key innovator in tech – there may be no stopping MSFT stock. At least, I can understand at this point why investors wouldn’t want to bet against Microsoft stock.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2019/04/bmw-deal-highlights-bull-case-microsoft-stock/.

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