Anyone paying attention to the markets over the past few weeks will have noticed some wild price swings. The S&P 500 had a nearly 5% return two weeks ago, making it the best week for the index in seven years. Then this past week, the S&P 500 declined 4.6%, giving up nearly all of the gains from the previous week.
What’s at the heart of these sharp increases and declines? Just when it appeared that the Trump administration and China attempted to solve their trade disputes, Canada, with the prodding from the Department of Justice, arrested the chief financial officer of Huawei Technologies for allegedly shipping U.S. products to Iran. This arrest occurred at almost the exact same time that the leaders of U.S. and China were sitting down to dinner at the G-20 summit. If these allegations are true, this would be a violation of U.S. sanctions. Also, on Friday, the U.S. jobs report for November showed hiring slowed to 155,000 new jobs, below the expected number of 198,000 new jobs. This slowing may or may not give the Federal Reserve pause when it comes to increasing benchmark interest rates when they meet later this month.
The point is that the markets have been seesawing back and forth recently because of the amount of news that investors have to digest. This means that some investors are not paying attention to company fundamentals. I try to circle back to companies that show that their businesses are strong whenever the markets become too emotional.
Stocks of these companies are often taken down along with the entire market in turbulent times. This makes these companies attractive because quality is now on sale. One company that investors looking for quality at a reduced price should consider is Microsoft (MSFT, Financial).
Company background
Microsoft develops, manufactures and markets both hardware and software to retail customers as well as businesses. The company provides operating systems, software development tools, video games and cloud services. Microsoft also provides social networking for the business community through LinkedIn. LinkedIn, which Microsoft purchased for more than $26 billion in June of 2016, allows members to showcase their talents to prospective employers. LinkedIn makes Microsoft a social media company.
Recent financial results
Microsoft released financial results for the first quarter of fiscal 2019 on Oct. 24. The company earned $1.14 per share during the quarter, coming in 20 cents ahead of expectations and growing 36% year-over-year. Revenue increased 18.6% to $29.1 billion. This beat estimates by $1.2 billion.
Each division of Microsoft saw solid growth. Productivity & Business Process saw sales grow 18% in constant currency to $9.8 billion. This division contains Office 365 and LinkedIn. Office commercial products and cloud services grew 16%, largely due to growth of 36% for Office 365. LinkedIn revenues were higher by 33%. LinkedIn sessions grew 34% as the service posted a quarterly record for messages, shared content and job postings. Microsoft has embedded LinkedIn directly into its Microsoft 365 network, making it easy for members to connect between services.
Intelligent Cloud revenues increased 24% to $8.6 billion. Server products grew 28%, primarily due to Azure’s 76% sales growth. This is a striking increase for Azure, but investors should be aware that revenue growth was above 90% for the past several quarters. Seventy-six percent growth is impressive, but slightly below previous totals.
Sales for the Personal Computing segment were up 15% to $10.7 billion. Windows original manufacture revenue improved 3%. Windows commercial products and cloud services saw higher volumes of multi-year agreements with customers, leading to 12% growth. Revenue for gaming was higher by 45% as Xbox software and services grew 36%. Search advertising was up 17% from the first quarter of fiscal 2018. Higher volumes for Microsoft’s Surface tablet led to a 14% increase in sales.
While the S&P 500 is flat for the year, shares of Microsoft have increased 22.5%. This kind of resilience, combined with strong fundamentals and solid dividend growth, should make Microsoft an attractive stock to own.
Microsoft expects to earn $4.25 per share in fiscal 2019. If achieved, this would be a gain of 9.5% from fiscal 2018’s total.
Dividend history and valuation
Microsoft has paid and raised its dividend for the past 17 years, making the company a Dividend Achiever. This is one of the longest dividend growth streaks available in the technology sector. The company has increased its dividend:
- By an average of 11.4% per year over the past three years.
- By an average of 13.9% per year over the past five years.
- By an average of 14.5% over the past 10 years.
Microsoft gave shareholders a 9.5% increase for the upcoming Dec. 13 payment. Microsoft will pay out $1.84 per share in 2018. This would equate to a payout ratio of 43.3% if the company reaches its expected midpoint for earnings per share. For comparison, Microsoft have a five-year average payout ratio of 47% and a 10-year average payout ratio of 39%. This shows that the company’s payout ratio is in a comfortable place and not over extended. Shares of the tech giant yield 1.76% currently, slightly below the yield of the S&P 500 (1.99%).
Based on Friday’s closing price of $104.82 and the company’s guidance for earnings per share, Microsoft’s stock trades with a price-earnings ratio of 24.7. This is above the stock’s five-year average price-earnings ratio of 18.9 and its 10-year average price-earnings ratio of 15.2. This is also higher than the price-earnings ratio of 21.5 for the S&P 500.
Conclusion
Against its own historical valuation or that of the market, shares of Microsoft are not cheap. This is often the case for companies growing earnings and revenues at high levels. These types of companies are attractive to investors due to their growth rates and are likely to be bid up to loftier valuations.
These stocks come down along with the rest of the market when trading becomes volatile. Companies who are able to show improving fundamentals should be considered for purchase during these times as investors can purchase quality companies at reduced prices. Microsoft saw growth among all of its divisions in the most recent quarter and expects to grow earnings per share at nearly 10% from the previous fiscal year. With a long dividend growth streak that predates the most recent recession, investors can rest assured that Microsoft is very likely to continue paying and raising its dividend in future years.
Disclosure: A member of the Sure Dividend Team is long Microsoft.
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