Microsoft’s Strong Earnings Showcase Why MSFT Stock Is a Winner

In late October, technology giant Microsoft (NASDAQ:MSFT) reported strong first quarter numbers which breezed past expectations, yet MSFT stock dropped after the print because of broader market jitters related to spiking Covid-19 cases and the coming U.S. Election.

microsoft stock
Source: Peteri / Shutterstock.com

These broader market jitters are transient. The world has innovatively and successfully adapted to the coronavirus pandemic, and spiking cases won’t derail the current economic recovery. Simultaneously, U.S. Election jitters will pass on November 3, once the election is over and uncertainty over who will be the next President of the United States turns into certainty.

Meanwhile, the drivers which pushed Microsoft to report strong first quarter numbers — such as a global enterprise pivot towards cloud-hosted infrastructure, productivity and communications solutions — are secular in nature. They will last for the foreseeable future.

To that end, the post-earnings dip in MSFT stock looks like little more than a buying opportunity. The bad stuff is short-term. The good stuff is long-term. Forget the bad stuff. Focus on the good stuff. And buy the dip.

Here’s a deeper look.

Microsoft’s Strong Earnings

Microsoft’s first quarter earnings report was very strong.

Both revenues and profits came in ahead of expectations, with revenues rising 12% year-over-year (largely consistent with the low double-digit revenue growth cadence Microsoft has established over the past few years) and operating profits jumping 25% year-over-year on the back of Covid-related savings. Ex those savings, it looks like operating profits would’ve risen about 15%, which again is largely consistent with the mid-teens profit growth cadence Microsoft has established over the past few years.

In other words, we are in the midst of a global pandemic, and Microsoft is reporting “business as usual” numbers.

That’s impressive — and it speaks to the secular nature of Microsoft’s growth drivers. That is, businesses across the globe are rapidly virtualizing their offices and operations, and pivoting towards cloud-hosted infrastructure, productivity and communications solutions in order to save costs, streamline operations and improve workflow efficiency.

This pivot had tremendous momentum before the Covid-19 pandemic. It still has tremendous momentum in the midst of the pandemic. And it will sustain tremendous momentum long after the pandemic passes.

Microsoft is meeting robust demand for these solutions with best-in-breed services, like Azure (revenues up 47% year-over-year in Q1), Office 365 (revenues +20%) and Dynamics 365 (revenues +37%).

So long as this cloud computing shift persists (it will for the next few years) and Microsoft continues to deliver some of the market’s best solutions (they will for the next few years), this company will sustain healthy growth trends regardless of the macroeconomic backdrop.

With that in mind, the post-earnings sell-off in MSFT stock looks like an opportunity.

Overshadowed by Macro Factors

Microsoft stock dropped despite strong quarterly numbers simply because the market is freaking out about the U.S. Election and spiking Covid-19 cases.

These are legitimate concerns. But they are also transient concerns.

The scary thing about the U.S. Election is the uncertainty. The market doesn’t particularly care who wins. Trump will mean lower taxes and higher earnings, but less stimulus and more geopolitical noise. Biden will mean higher taxes and lower earnings, but more stimulus and less geopolitical noise. It’s six of one, half a dozen of the other.

Instead, what the market is freaked out about is not knowing who will win. Markets hate uncertainty. Elections are the quintessence of uncertainty. But the good news is that, come early November, all that uncertainty will disappear. Once it does, U.S. Election jitters in the market will also disappear.

Meanwhile, spiking Covid-19 cases are a concern, especially since they are causing a new round of lockdowns across Europe. But, these lockdowns won’t kill the economic recovery, because as a global society, we’ve learned how to sustain economic and social normalcy even when we are all quarantining, and that’s by leaning more heavily into virtualized and digital services.

All in all, the market’s freaking out about a few macroeconomic headwinds, but in the big picture, those headwinds are ephemeral and are not deal-breakers.

So, with MSFT stock down on strong earnings because of these ephemeral macro headwinds, I say buy the dip.

Buy the Dip in Microsoft Stock

Relative to the company’s promising growth prospects, Microsoft stock is reasonably valued.

Here’s the math.

Enterprise cloud spending trends will be the primary fuel for Microsoft’s revenue growth over the next several years. But, also factoring in there will be increased video game engagement boosting the Xbox business, and a recovery in digital ad spending sparking reinvigorated growth at LinkedIn and in the Bing search business.

Connecting all the dots, it seems quite likely that Microsoft sustains 10%+ revenue growth for the next five years. Gross margins should improve as the company’s cloud businesses scale. Concurrently, Microsoft’s operating expenses have grown at a 6% compounded annual growth rate over the past five years, so 10%+ revenue growth should drive positive operating leverage.

Steady 10%+ revenue growth on top of margin expansion drivers should power somewhere around 15% profit growth over the next five years.

Assuming so, my modeling pegs fiscal 2026 earnings per share at $13. Based on a systems software sector-average 25x forward earnings multiple and an 8.5% annual discount rate, that implies a fiscal 2021 price target of $235.

Thus, I think MSFT stock has fundamentally supported upside potential of 15% over the next 12 months, which is pretty good in an environment with a sub-1% 10-year Treasury yield.

Bottom Line on MSFT Stock

Microsoft’s earnings confirm that MSFT stock is a long-term winner. Near-term weakness is just a function of ephemeral headwinds that will pass in the coming weeks. So buy the dip. Weather the storm. And let the fundamentals continue to drive this stock higher in a multi-month and multi-year window.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

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Article printed from InvestorPlace Media, https://investorplace.com/2020/10/microsofts-stock-strong-earnings-msft-is-a-winner/.

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