Most investors seem to be confused about the future growth and profitability of Microsoft (MSFT), after the relatively poor performance of Windows 8 and Windows phone. For some reason, investors are not impressed by the company and it has been left behind by its peers, Google (GOOG) and Apple (AAPL). However, the stock price and the company's profitability are not bad. In fact, the stock price has increased by more than 25% during the last year. If we look at the financials and the fundamentals, the stock looks attractively priced and I believe Microsoft's price is only suffering due to the excitement about the other two stocks mentioned above.
If You Can't Beat Them, Join Them
It was recently reported that the company is considering the option of altering its operating system to support the Android apps on Windows phones. The primary reason why Windows phones have lower market share is that it does not offer the freedom to the users. While Apple is known for innovation and exclusivity, Android came with the idea of a free and open app development plan. The successful execution of the strategy can bring considerable benefits for the company and Windows phones will certainly get a bigger market share. The biggest reason behind the lower popularity of Windows Phones was the limitations in its apps compared to the apps offered by the iOS and Android platforms. If Microsoft were to come up with the adjustments in its operating system to support Android apps, its sales will surely be enhanced.
The main objective of the "Windroid" strategy is to get people to start buying Windows phone. Once this happens, the users can freely use Android apps on their Windows operating systems just like any other Android based phone. If things work out for the company as discussed, the smartphone business could become a cash cow for Microsoft. Furthermore, cloud computing is becoming the future of the sector and all of the major players are focusing on this segment. Microsoft has also put its focus on this segment and the promotion of the company's cloud computing and enterprise business. I believe Mr. Nadella will try to further the cloud computing business of the company which should enhance the revenue growth.
Migration and Upgradation
When we talk about the future growth of Microsoft, we often overlook the fact that the Windows operating system is running on the majority of the computers around the world. The upgradation or migration to the newer versions of Windows alone can account for substantial growth in revenues for the company. In less than two months, the company will stop support for Windows XP -- the users will still be able to use the operating system but there will be no support from Microsoft -- there will be no patches, upgrades or security fixes for the users. As my fellow SA author points out, 20% of the corporate computers in North America and Europe still use Windows XP. Due to the security concerns, these systems will have to be upgraded to the newer versions of the operating system. Furthermore, around 400,000 ATMs in the U.S. running on Windows XP will also need an upgraded operating system.
Microsoft is in an incredible financial position. The revenues are still increasing on year-over-year basis, last reported at 5% during 2013 while earnings per share increased by 29%. Also, the company has been efficiently managing its assets by selling off its unused fixed assets to put its money to better use. In 2013, Microsoft sold $4.2 billion worth of its fixed assets. This would allow the company to enhance its research and development budget if the company deems it necessary. Most importantly, the company has a very strong financial backing. It has $101.4 billion dollars in its current assets, out of which $80 billion dollars are cash in hand and short term assets. The company can easily meet its total liabilities of $63.4 billion with only its cash in hand and it would still be left with over $16 billion dollars in cash and short-term securities.
If we look at the fundamentals only, it is hard to categorize Microsoft as anything other than a buy. The company has seen its revenue rise by over 60% during the last six years, showing a compound annual growth rate of over 8%. During the same period, the company has been able to more than double its operating cash flows - Microsoft converts 40% of its revenues into cash flows, which gives it a considerably high revenue-to-cash conversion ratio. Furthermore, the forward price-to-earnings ratio of 12.5 is below the industry average of 16. In addition, the stock pays an attractive dividend yield of over 2.5%, and as I mentioned above, the cash reserves of the company are massive.
As I mentioned above, the stock is a buy based on the strong fundamentals and future growth prospects, in my opinion. Microsoft's Windows operating system is still the leading operating system in the world and just the upgradation to the newer version will bring in substantial revenues. Furthermore, the company is working on its cloud computing offerings and building its own ecosystem that can challenge the other two peers. At current price levels, I believe Microsoft is an extremely attractive investment and it will make substantial upward movement over the next twelve months.