The world’s top software company has not been immune to the 2022 sell-off and bear market. Despite its remarkable financial strength, resiliency, and bright future prospects, Microsoft stock (NASDAQ:MSFT) has sold off more than the S&P 500, albeit it is slightly ahead of the NASDAQ year to date.
While recent stock performance has been dismal, pushing Microsoft stock from an all-time high to a multi-year low, the company’s core fundamentals have never been stronger. Of course, there are some macroeconomic issues, but where else would you put your money? In overpriced speculative names or well-established firms with outstanding fundamentals and fantastic prospects?
Prospects for Growth and Long-Term Business Lines
Microsoft’s most essential solutions have transitioned from discs and single purchases to a SAAS model. This is not only more efficient and profitable, but it also simplifies client decisions and lives.
Microsoft is constantly evolving. The company and its management have proven to be not just professional but also forward-thinking in areas ranging from operating systems to business software packages and games.
Aside from these traditional revenue streams, Microsoft has grown its cloud computing service, Azure, into an industry leader. Microsoft’s cloud computing solutions, including Azure, accounted for approximately half of the total revenue in the fiscal quarter ending June 30, 2022, and are expanding at a rate of more than 30% per year with gross margins of 70%. Except for Xbox content and services and Office Commercial Products, all lines of business have grown by double digits. The stronger currency partly exacerbated the income decline, but it would have been negative regardless.
Microsoft has also made inroads into the lucrative online advertising market. Last year, it acquired Xander, a global advertising marketplace, from AT&T (NYSE:T), which helped it win the ad placement business for Netflix’s (NASDAQ:NFLX) new ad-supported model for lower monthly membership costs. The company’s search and advertising revenues are increasing at a 20% annual rate. In addition, the company returned a considerable amount of capital to shareholders over the prior quarter. Microsoft returned $12.4 billion in the quarter through share repurchases and dividends, a 19% increase year-over-year. In recent weeks, the company also announced a 10% dividend increase for the next dividend, which will be paid on November 16. Microsoft’s dividend has climbed at a compound annual growth rate (CAGR) of more than 11.6% during the last nine years.
A Possible Netflix Acquisition?
Although this is theoretical, Microsoft is the only major technology or communications business with no streaming service. The advertising connection with Netflix may supply Microsoft with the information it requires to execute a purchase. Microsoft could effectively buy Netflix in cash at its current market cap. Furthermore, because a Netflix acquisition would most likely not hurt any section of the market, anti-trust concerns would be minimal, even for such a massive purchase, in my opinion.
Microsoft Stock Valuation
Microsoft stock is appealing in terms of valuation. While it is trading at a higher multiple than many of its rivals, Microsoft stock is still trading at a lower multiple than its history.
For both its future and trailing P/E ratios, the company is trading at a significant discount to 5-year averages. Microsoft stock is selling at a 20-25% discount to its five-year average for numerous valuation multiples.
While valuations are below multi-year highs, returns have been consistent and in line with previous years. For example, over the last 12 months, returns on total capital were 22.2%, compared to a five-year average of 16.9%. Similarly, in the previous twelve months, ROE and ROA were 47.15% and 19.9%, respectively, compared to the 5-year average of 38.9% and 14.5%.
Gross profit margins have remained stable at around 67-68% over the long term, whereas net income margins have improved from 29.7% to 36.7% during the last year.
I anticipate that the earnings report on October 25 will show ongoing strength across the board, with comparable growth and margins to what the company has consistently produced.
Catalysts
Microsoft has entered the advertising industry, earlier assisting Meta (NASDAQ:META) and now Netflix. The acquisition of Xander from AT&T has enhanced the company’s efforts in the field.
Aside from the ad business, Microsoft has other present and possible new prospects that, despite the company’s age, make this a value and growth firm at these rates.
Azure and other cloud-related services are leading the charge. This revenue stream already accounts for about half of total revenue, grows at a rate greater than 30% per year, and has gross margins in the 70% range.
What is maybe surprising is the level of revenue increase generated by LinkedIn for Microsoft. Last quarter, revenue for that business increased by 26%, owing to increased sessions and record levels of engagement. In 2016, Microsoft paid $26.2 billion for LinkedIn, a company with $13.8 billion in revenue in fiscal 2022, while operating margins have not been reported since 2019.
Is Microsoft Stock a Buy?
I’ve been a Microsoft shareholder for over 10 years. I believe Microsoft is an ideal place to invest some capital for those looking to capitalize on today’s low prices, particularly for high-quality companies with excellent growth prospects.
Featured Image- Unsplash @ Turag Photography
