- Microsoft demonstrates that size is no hindrance to performance.
- Microsoft's next quarter guidance looks promising.
- How shareholders should think about Microsoft Cloud's prospects.
- Microsoft is priced at 36x forward earnings, seriously not expensive for what's at play here.
- I do much more than just articles at Deep Value Returns: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
Microsoft (NASDAQ:MSFT) continues to surpass all expectations, as its top line continues to grow at more than 20% CAGR, and its guidance for the next quarter also looks very promising.
Investors are asked to pay 36x forward earnings for a company that's evidently still a growth company, despite being the biggest company in the world.
For buy and hold investors, that wish to buy right, hold tight and forget, look no further than Microsoft, here's why:
Microsoft's Revenue Growth Rates Accelerate?
Source: author's calculations, **company guidance
Unimaginable as it may seem, Microsoft's top line was up 22% for Q1 2022. Even now, this dinosaur in technology years is still a rapidly growing business. And it's even more attractive when you note that its guidance for the quarter ahead points to nearly 20% CAGR, once again.
Now, consider the following figures, Microsoft's free cash flow during Q1 2022 reached just under $19 billion. Of that free cash flow, more than 60% returned to shareholders via share buyback or dividends.
So what you have is a business that's clearly investing for growth, growing at a rapid clip, with non-GAAP EPS figures up 23% y/y.
Why Microsoft Now?
Microsoft put Q1 2022 results showing that the biggest opportunity it continues to face is the cloud. Despite Microsoft Cloud reaching nearly $21 billion in revenues over the past quarter, it succeeded in being up 36% compared with the prior year.
As a reminder, Microsoft Cloud is formerly commercial cloud. Microsoft Cloud revenues come from Azure, Office 365 Commercial, and Office Products to mention a few business units. Its revenues are spread amongst different segments so we don't have a clear operating profit profile for these revenues.
What's more, keep in mind that Microsoft Cloud is aimed squarely at enterprises, and does not include any revenues from Microsoft's Consumer cloud services.
Altogether this starts to give investors some scope of the size of Microsoft's cloud exposure. Also, keep in mind that predominantly, Microsoft annuity revenues reached 95%. This provides Microsoft with incredible stability, reliable cash flows, and visibility.
Hence, when investors start to push back that Microsoft is already the biggest company by market cap, I posit to readers, how many cloud companies are out there growing at tens of billions per 90 periods, with 71% gross profit margins and doing so at more than 30% CAGR? Asides from Amazon, I believe that readers will struggle to forward me many names.
To illustrate further, I have a lot of admiration for Alphabet, but as I discussed last week, its Cloud exposure is still some way away from reporting $10 billion of cloud revenues per quarter:
Source: author's work
What's more, consider that 78% of the Fortune 500 use Microsoft's hybrid solutions. In my last Microsoft article I wrote:
[Fortune 500] are companies with the financial resources and technical acumen to demand only the best of the best hybrid cloud. And by far and wide, the bulk of these global enterprises still chose Microsoft's cloud platform.
Needless to say that I stand by that comment. Companies that require peace of mind for their mission-critical work, will seek Microsoft for reliability and the strength of its brand.
No one will ask difficult questions if a company adopts Microsoft for its cloud solutions. Can the same be said if a company adopts a slightly smaller, up-and-coming cloud provider? I doubt it. It's like an insurance policy, for the head of IT, no one will fault the head of IT for going embracing Microsoft's cloud offering. Microsoft's cloud services provide analytics, data integration, and warehousing. It's a one-stop-shop cloud solution for any enterprise.
As the global workforce increasingly works from anywhere, employees need the right tools to ensure that the hybrid work is seamless. Microsoft breaks down IT silos and ensures collaborative efforts don't have added layers of friction.
Now, let's discuss Microsoft's valuation.
Valuation - MSFT Stock Still Attractively Priced
Microsoft is priced at 36x forward earnings. Not sales, but actual earnings. As noted higher in the article, Microsoft is growing its bottom line at more than 20% CAGR. Thus, paying 36x forward earnings for a company that touches nearly every single business somewhere along their productive day doesn't strike me as expensive.
You can think of Microsoft as a toll bridge, where every business passes through, and Microsoft collects a fee along the way.
The Bottom Line
Microsoft continues to report solid bottom-line growth, and yet, despite being the biggest company in the world it's still attractively priced at 36x forward earnings.
Microsoft is incredibly cash flow generative, returns meaningful capital to shareholders, and provides few negative surprises to shareholders.
All that being said, I prefer to deploy my own capital into smaller cap stocks. Good luck and happy investing!
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This article was written by
Michael Wiggins De Oliveira is an energy specialist whose primary focus is capitalizing on “the Great Energy Transition” - the confluence of decarbonization, digitalization with AI, and deglobalization - to achieve greater investment returns. Through his 9+ years analyzing countless companies, Michael has accumulated outstanding professional experience in the energy sector and a following of over 40K on Seeking Alpha.Michael is the leader of the investing group Deep Value Returns. Features of the group include: Insights through his concentrated portfolio of value stocks, timely updates on stock picks, a weekly webinar for live advice, and "hand-holding" as-needed for new and experienced investors alike. Deep Value Returns also has an active, vibrant, and kind community easily accessible via chat. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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