Microsoft Stock: Q2 Earnings Are a Good Sign for the Future

Microsoft Stock

Microsoft Stock (NASDAQ:MSFT)

Microsoft Corporation (NASDAQ:MSFT) is one of the world’s largest and most successful technology companies, offering software licensing and sales, consumer electronics, personal computers, cloud computing services, and so on. The company’s most well-known products are the Windows operating system, the Microsoft Office Suite, Microsoft Azure, and the Xbox gaming console.

An Attractive Investment Opportunity

Microsoft stock remains an appealing investment opportunity. The company has a diverse product offering, is cutting costs with a 5% workforce restructuring, and is investing heavily in the future with a $10 billion investment in Open AI. Furthermore, the cloud computing segment remains robust, with operating income exceeding 40% and revenue growth in the high double-digit teens. Let us now examine the fiscal second quarter results.

Microsoft recorded its slowest revenue growth in more than five years during the second quarter of FYE 2023. Revenue increased by 2%, driven by its cloud computing segment, which increased by 17.8%, or $3.2 billion. Revenue growth in the personal computing segment was largely offset by declines in Windows (-27%), Devices (-39%), and Gaming (-13%).

Employee severance expenses increased by 19% due to layoffs, investments in cloud engineering, and the Nuance acquisition. Expenses for research and development increased by $1.1 billion, or 19%, due to investments in cloud engineering. As a result, operating income fell to $20.4 billion from $22.2 billion in the same period last year. Despite higher operating expenses, Microsoft maintained healthy profit and operating margins of 38.7% and 31.1%, respectively.

Microsoft generated $4.9 billion in free cash flow. This free cash flow generation needed to be more sufficient to cover the $10.5 billion in shareholder returns. As a result, cash and cash equivalents fell to $99.5 billion. For comparison, cash and cash equivalents totaled $107.2 billion in the previous quarter.

Microsoft’s Intelligent Cloud segment increased by 17.8% to $21.5 billion, continuing its upward trend. Despite a slowdown compared to last year’s period, the segment is still experiencing robust growth. The segment has a healthy operating margin of 41.4% and currently accounts for 41% of total revenues. The operating margin fell compared to last year’s period, owing to $1.6 billion in higher operating expenses.

Employee severance costs, Azure investments, and the Nuance acquisition contributed to expenses. It is worth noting that Nuance is a market leader in conversational AI and ambient intelligence in industries such as healthcare, finance, retail, and telecommunications. This will assist the Intelligent Cloud segment strengthen Microsoft’s capabilities in these industries. Furthermore, layoffs and investments in cloud capabilities will help reduce costs in subsequent quarters.

Many people might wonder why I’m so interested in Search and News Advertising. This is because the business’s leaders have said they want to grow it to $20 billion. So, it is very important to keep a close eye on how this source of income is doing. Microsoft just confirmed a $10 billion investment in OpenAI, the company that made ChatGPT, in addition to the management’s promise to grow the business. This makes me think that Microsoft is planning to challenge Alphabet’s (NASDQ:GOOGL) strong position in the web search market. Lastly, this investment in Open AI could make Microsoft’s Bing search engine better by taking advantage of possible synergies.

Search and News Advertising revenue increased by $159 million, or 5.2%, to $3.2 billion in the second quarter, accounting for 6.1% of total revenues. Although at a slow pace, this revenue stream’s impact on the company’s overall top line is growing. While the year-on-year growth is not spectacular, it is a positive highlight for the quarter when compared to decreases in Windows (-27%), Devices (-39%), and Gaming (-13%).

Microsoft’s management faced major decisions during the second quarter of FYE 2023. The first significant decision to be discussed is the layoff of nearly 5% of the company’s workforce. Employee severance costs will have a short-term financial impact on the company’s financials. However, in the medium to long term, the company will be able to operate more efficiently and with greater cost control.

Second, Microsoft announced a $10 billion investment in OpenAI, a major investment in artificial intelligence. It is worth noting that Microsoft already invested $1 billion in OpenAI in 2019. This strategic move will assist the company in achieving synergies across its various products and services. Furthermore, it will provide Microsoft with the necessary tools to compete more effectively in this field with Google, Amazon (NASDAQ:AMZN), and Meta Platforms (NASDAQ:META). It should be noted that OpenAI will use Azure as its cloud provider, which will essentially improve Microsoft’s Intelligent Cloud segment.

Finally, Microsoft’s massive bet on the gaming industry has yet to be cleared by regulatory bodies. The Federal Trade Commission blocked the acquisition of Activision Blizzard (NASDAQ:ATVI), and management did not say much about it during the earnings call. It did, however, state that it is still working to obtain the necessary regulatory approvals.

In Conclusion

Microsoft stock remains an appealing long-term investment opportunity. The company’s fundamentals remain strong; it is cutting costs by 5% in the workforce while investing heavily in artificial intelligence with a $10 billion investment in OpenAI.

Looking at the big picture, the artificial intelligence market is expected to exceed $400 billion by 2028. This investment will enable Microsoft to capitalize on this expanding market. Cloud computing continues to experience strong growth and healthy operating margins. Finally, if Microsoft successfully acquires Activision Blizzard, it will gain a dominant position in the gaming market, which is expected to reach $390 billion by 2027.

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About the author: Stephanie Bedard-Chateauneuf has over six years of experience writing financial content for various websites. Over the years, Stephanie has covered various industries, with a primary focus on tech stocks, consumer stocks, health stocks, and personal finance. This stock lover likes to invest for the long-term. Stephanie has an MBA in finance.