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Nicholas Kitonyi
Nicholas Kitonyi
Articles (246)  | Author's Website |

Microsoft Is Rapidly Evolving Into a Growth Stock

Top-line CAGR of about 30% over the last five years versus 16.9% historical is impressive

Microsoft Corp. (NASDAQ:MSFT) reported fiscal third-quarter earnings results Thursday after markets closed, beating street estimates on both revenues and earnings. The company’s top line grew 15.6% year-over-year, and beat analyst estimates by $1.05 billion to top $26.8 billion for the quarter.

The computing giant also surprised on earnings, beating analyst estimates of 85 in earnings per share by 10 cents after posting diluted earnings per share of 95 cents, a 31% increment from the figure posted the same period last year.

Microsoft’s productivity business, which includes revenue from the 2016 acquisition of professional networking giant LinkedIn, grew 17% year-over-year to top $9 billion, reflecting a constant currency growth of 14%. On the other hand, its intelligent cloud unit was up 15% on a constant currency basis after reporting a top line of $7.9 billion, while the personal computing unit grew 11% on a constant currency basis.

The company’s percentage gross margin remained unchanged at 65% from last year but was up 13% on a constant currency basis in monetary terms while operating income increased 20%. Microsoft’s revenue per share growth trendline has averaged 16.9% annually historically. However, this has rapidly changed over the last five years with an estimated CAGR of about 30%.

The company has adapted to its business to innovative technologies like Intelligent Cloud to augment revenues from its productivity and business processes segment as it seeks to supplement its newly reinvented personal computing unit.

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Via company presentation slides.

Microsoft has also continued to enjoy strong operating margins, posting 31% in the most recent quarter, which reflected an improvement of 2 percentage points from the same period last year.

The company’s intelligent cloud segment’s growth has been boosted by the rapid growth of Microsoft Azure, which since launching in 2010 has averaged a three-digit growth rate. In the most recent quarter, Microsoft Azure cloud computing services grew by a whopping 93% which, ironically, is one of its slowest growth rates.

Azure’s rapid growth has propelled Microsoft’s market share in the cloud services market to 14% and now sits second only to Amazon.com Inc. (NASDAQ:AMZN)'s Web Services (AWS), which commands 32% market share.

On the other hand, Office 365 productivity suite has been one of the main top-line growth drivers in the productivity and business services unit. The company’s Office Commercial segment has been averaging a growth rate of about 42-45% over the last few years. Dynamics 365 also saw a massive top-line growth rate after delivering a 65% growth from sales posted the same period last year.

Looking at some of these figures, it explains why the company’s average top-line growth rate has risen so rapidly in the last five to seven years, which also coincides with the introduction of some of its high growth services like Azure.

The company’s stock price responded in kind following the company’s strong fiscal-year third quarter 2018 performance, gaining 3.5% to trade at $97.50 per share in the early hours of trading on Friday morning, recording a net gain of 6% from Wednesday’s close of about $92 per share.

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Following Friday's early surge, shares of the company traded at a price-earnings ratio of about 29, which is a rich valuation multiple compared to some of its close peers like Apple Inc.’s (NASDAQ:AAPL) 16 price-earnings ratio and Intel Corp.’s (NASDAQ:INTC) 17 price-earnings.

However, the company is rapidly becoming a growth stock, and this means that investors might be willing to pay a higher premium to be part of its next revolution. Currently, earnings are growing at a rate of the mid-to-late 20s, which again demonstrates that its investments over the last decade are beginning to pay off.

Therefore, perhaps it is more reasonable comparing the company’s valuation multiple with those of other growth giants like Amazon, Netflix Inc. (NASDAQ:NFLX) and Facebook Inc. (NASDAQ:FB), but the jury is still out. It will be interesting to see how the company develops over the next few years.

In summary, Microsoft is a top-quality company and its transformation from a defensive stock in a rapidly changing industry into a growth stock appears to be taking shape. Therefore, even with its rich valuation, some investors might still find a reason to invest in one of the most disruptive companies of the 20th century.

Disclosure: I have no position in stocks mentioned in this article.

About the author:

Nicholas Kitonyi
Nicholas the founder of CAGR Value. He is a financial analyst with extensive experience in investment research and stock market analysis. His analysis has been featured on research sites like Seeking Alpha and Benzinga.

Nicholas has solid knowledge of both U.S. and European markets. His investment style is focused on undervalued plays and growth stocks. As a trader, Nicholas classifies himself as a swing trader and likes to trade GBP/USD, gold and FTSE 100, among other liquid instruments.

Visit Nicholas Kitonyi's Website


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