Microsoft Continues To Be A Growth Stock; Buy The Dip – Seeking Alpha

Microsoft (NASDAQ:MSFT) remains the king of tech, all these years later growth continues, new products impress, and the software monopoly continues. It is not wise to bet against Microsoft.

Microsoft rebounds in 2017

2016 was a slow year for Microsoft. However, 2017 shows a recovery in growth. Recent quarter EPS grew 28% year-over-year, and revenue increased 11.19%. Productivity and Business Services increased the most (year over year), increasing by an impressive 17.4%.

During the same month as Microsoft reported Q4, the company also announced Microsoft 365; a new addition to the Productivity and Business Services segment. Microsoft 365 already has some large customers, FedEx (NYSE:FDX), Dow Chemical, and Progressive Insurance have all chosen Microsoft 365. Proving yet again why you should own Microsoft in your portfolio.

You can see below that a significant source of growth comes from the Productivity and Businesses Processes segment, I believe that continued investment and the new enhancements to this segment will drive revenue growth.

Segment forecast by author

Microsoft is also offering products to the education industry that boost efficiency and make workloads easier; In the name of Microsoft Teams. Microsoft Teams gives teachers an advantage in the classroom, with a new way to create and excite students. In the U.S., there are around 90,000 Elementary schools, both public and private; this opens up more opportunity for Microsoft to grow this sector.

LinkedIn shows new growth hopes; despite operating loss

Microsoft seems to be showing results with LinkedIn. Recently they released a new messaging service that showed unprecedented levels of messages being sent back and forward. Microsoft has always, from the early days, focused on businesses, and LinkedIn is the social media platform for business; buying Linkedin was a bold, and well thought out move.

When the deal went through last year, Tom Warren from the verge said:

LinkedIn provides Microsoft with immediate access to more than 433 million members and a solid social graph that, thanks to its professional nature, is matched closely with the software and services Microsoft provides. In the same way that most kids play Minecraft, it’s reasonable to assume most adults in the US use LinkedIn for finding jobs, connecting with colleagues, or just general work-related networking. - Source: The Verge

LinkedIn helps Microsoft’s overall revenue by approximately 5 points and adds only slightly to gross margin expansion.

However, the loss from operations at LinkedIn dragged Microsofts total operating income down somewhat.

Operating expenses at LinkedIn widely outpace revenue; to the tune of 361 million dollars this quarter alone.

Microsoft get serious on VR/AR; not likely to add much growth to revenue

The majority of VR products are heavily overpriced for the likely everyday user; we are seeing a dramatic drop in prices now to reflect the sluggish demand; oculus was $598 now $399.

Microsoft announced that they are holding a “mixed reality” event on October the 3rd; this will apparently show off some new Microsoft product in the VR/AR world.

VR is a new phenomenon; most companies are struggling to sell products to a great volume, even the VR phone market seems to be dwindling cash; the fad appears to have been muted as of recent. However, demand will be issued as the demand curve shifts to the right with lower prices bringing in more consumers.

Source: TechCrunch

We are still very much in the early stages of VR, the clunky headsets of today will be laughed at in just a few years, as technology in this field improves at an exponential rate.

The market currently looks big, for Microsoft to not play around and produce products in this area would be a missed opportunity, as this technology will take over from the traditional video games industry; the more integrated in-depth gameplay will be seen as the natural aptitude for gameplay consumption.

Source: TechCrunch

Valuing Microsoft

As you can see from the chart above, heading into the next quarter and onwards, I expect to see a vast improvement in gross profit per share, as management continues to buy back shares, and profit margins widen; during the last quarter gross margin grew 11% in constant currency. Commercial cloud margin increased by 92% showing strength across all services offered.

Commercial cloud margin grew by 92% showing strength across all services offered.

Overall gross margin I assume to be averaging around 65% in the model below.

Microsoft is a mature company, but as of late, the company has been behaving more like a growth company once again.

The shift to more online/subscription model based services will continue to drive Microsoft’s vital revenues for the foreseeable future, and it is for this reason I have assigned a price to earnings ratio of 27x on the stock. Upside from here offers 23%; when looking at 2018 forecast EPS.

For 2017 year-end, I assume to see the stock price reach $81.97; with an EPS of $3.04ttm; this would give the stock a further 9.7% to the upside for investors.

Risks to model assumptions:

  • A more competitive cloud computing space could result in lower gross margins as companies would have to outbid each other for clients. Although Microsoft is on track and showing strength with gross margins, the cloud computing industry, with the likes of Amazon and others, could steal market share, resulting in low revenues.
  • Management could cut back or reduce share buybacks; this will result in a lower EPS forecast in the earnings model, which in turn would lead to lower stock price projections.
  • Microsoft largest segment “More Personal Computing” could see some declines; “More Personal Computing includes Windows, Bing search, and Microsoft hardware, from Surface and smartphones to Xbox.” according to Computerworld

Final note

The above model implies $95.6bln in revenue year-end. Gross margins look to continue to improve, and the longer term picture for Microsoft looks even better. The model implies 10.16% upside for year’s end, although this is the target produced in the model, I would be a little bit more skeptical and assume Microsoft has a further 8 to 9% upside at most. The market overall as rallied hard this year, and we are already close to 15%.

The majority this is driven buybacks, and the Federal Reserve buying bonds, which in turn pushes yields lower, and forces investors to dive into equities as they chase returns. Recently, the Fed has announced that they are unloading the balance sheet; the reverse will happen to what has been mentioned above (to an extent), this is also why investors should be extra cautious in the coming months.

However, with that being said, I still hold my buy recommendation on Microsoft with a 2017 year and price target of $81.97.

Disclosure: I am/we are long MSFT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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