Microsoft Corporation May Just Be the Perfect Stock

I hate to call anything a “perfect” anything. When it comes to stocks, I confess that “perfect” is a bit of hyperbole. Perhaps a better term is “solid long term hold for a diversified portfolio,” but that’s a mouthful. Regardless, that’s what Microsoft Corporation (NASDAQ:MSFT) is.

I want to break things down a bit from the Jan. 31 earnings report because it was indicative of why Microsoft stock is so strong.

Recall that MSFT was on top of the world back in 2000. When Microsoft was declared a monopoly, Bill Gates resigned as CEO shortly thereafter, and put Steve Ballmer in charge. Everyone had high hopes, but Ballmer basically rode the wave and let Microsoft stock flail as the company lost direction. Then he resigned and Satya Nadella took over.

And everything has changed.

MSFT is a legit growth stock again.

Microsoft Stock’s Numbers

In the second quarter, the Productivity and Business Processes division reported revenue of $9 billion, up 25%. Office 365 commercial revenue was up 41%, so I guess the rejiggering of strategy for that arena has worked out beautifully.

The Intelligent Cloud division reported revenue of $7.8 billion, up 15%. The More Personal Computing division reported revenue of $12.2 billion, up 2%. Total revenue was $28.9 billion, up 12%. Gross margin of $18 billion was up 12%. Gross margin percentage is huge, at 62%. Operating income hit $8.7 billion up 10%.

Net income rose 20% to $7.5 billion.

These are phenomenal numbers. Nadella has proven that Microsoft stock is now driven by a vision, not by a guy resting on company laurels.

With its massive cash hoard, not only did Microsoft stock generate $3.3 billion in free cash flow, up 23% year-over-year, but this was the result of working capital improvements, as well as LinkedIn. Plus, MSFT generated another $490 million just from investments on its cash hoard.

I have to admit that I never understood the business model of LinkedIn or why MSFT paid so much for it. But Nadella sure understood it. Income at LinkedIn was $228 million in Q2 of Fiscal Year 2017. In just the following quarter, revenue rose four-fold to $976 million. Holy crap!

Bottom Line on Microsoft Stock

Then it went up to $1.07 billion in Q4, to $1.15 billion in Q1 of FY18, and $1.31 billion in Q2. Obviously, Nadella and the team had a vision and immediately executed on it.

Yet this all came as a result of cost of revenue increases that didn’t come close to revenue generated. The total cost of revenue in Q2 of FY17 was $166 million. By Q2 of FY18, it was $642 million. It increased $476 million while revenue increased by $1.1 billion. Operating expenses increased from $305 million to $1.15 billion, when you back out profit.

MSFT stock trades at around 26x Trailing 12 Months earnings. When you look at net income growing at a 20% clip, and add in premiums of 10% each for cash position, free cash flow and a world-class brand name, I do see a 26 price-earnings ratio as being reasonable.

It may even be cheap, because I permit a price/earnings to growth ratio of up to 2.0 on stock growing earnings per share at 15% or more. Thus, Microsoft stock may indeed be a Growth at A Reasonable Price stock.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.

Let's block ads! (Why?)