Markman Capital Insight

How Old-Man Microsoft Grew Like A Kid Last Year

To learn how to improve your results in the market dramatically by buying options on stocks like Ford and Tesla, take a two-week trial to my special service, Tactical Options: Click here. Members have made more than 5x their money this year.The first batch of tech corporate earnings reports are rolling out. They are surprisingly great.Microsoft (MSFT)...

To learn how to improve your results in the market dramatically by buying options on stocks like Ford and Tesla, take a two-week trial to my special service, Tactical Options: Click here. Members have made more than 5x their money this year.

The first batch of tech corporate earnings reports are rolling out. They are surprisingly great.

Microsoft (MSFT) reported another blowout quarter Tuesday after the close. Despite rumors about the maturity of its businesses, sales and profitability are accelerating. And there is plenty of runway.

It’s time for Microsoft-bashers to move on. This is a great investment story.

It’s noteworthy that Microsoft’s good fortunes stem from the corporate transition away from products that competed directly with Apple. Today, the Redmond, Wash.-based company is a long way from the Mac vs. PC wars. Windows, its flagship operating system is still a big business yet even it has moved beyond walled gardens. Managers went from trying to shoehorn Windows onto smartphones, servers and networked appliances to bringing its services to platforms of all types.

The Microsoft Office productivity software suite lives as comfortably on Linux-based data center servers, as on Android, Mac OS, iPhones and iPads. This transition helped Microsoft materially grow its business beyond Windows.

Tuesday the company reported second quarter earnings of $2.48 per share, up 22% from a year ago. Revenues ballooned all the way to $51.7 billion, an increase of 20% year-over-year, according to the official investors relations blog post

The biggest part of better fortunes was concentrated in the commercial cloud business segment where Q2 sales shot up to $22.1 billion, 46% better than a year ago.

The opportunity in cloud computing is a drum Satya Nadella, chief executive officer has been beating for several years. Now it is clear demand for these services are accelerating as enterprises orchestrate the second phase in their digital transformations.

Nadella says Microsoft is in the best position to help companies make this transition because of its large portfolio of integrated products and services. That could all be true yet it’s far more likely that Microsoft’s good quarter is a harbinger for the sector in general.

The cloud services business is growing fast.

The Wall Street Journal noted on Tuesday that analysts at International Data Corp. expect the sector surge from its run rate of $385 in 2021 to $809 billion by 2025. Microsoft Azure is the second largest infrastructure business, behind only Amazon Web Services.  

It’s the part of the story many bashers leave out: The cloud is a digital transformation story and it is early innings. Eventually all large and medium-sized businesses will have a digital strategy and it will be built around cloud-based processing and data storage.

Microsoft is unique due to its extensive portfolio of enterprise clients, and the firm’s ability to put together package deals that crisscross cloud, productivity software suites and computer hardware.

The best part is all of these businesses, like the Xbox gaming platform, are subscription based. It’s easy to see where future sales are coming from. The customers are renting the software.

Nadella said on Tuesday that Game Pass, its cloud-based gaming subscription business, hit 25 million members during the quarter. That is up 39% from a year ago.

The planned $75 billion acquisition of Activision Blizzard (ATVI) will help grow Game Pass. Activision is the studio behind key game franchises such as Call of Duty, Overwatch and Candy Cush.   

At a price of $288.49, Microsoft shares currently trade at 27.3x forward earnings and 12.5x sales. Bears have argued for several years the stock is expensive based on its price-to-book value. That is probably the wrong metric.

The Microsoft story is more about a company with $200 billion in organic sales and still managing to grow at a 20% clip. With 68.9% gross margins, the cash flow is crazy.

Longer-term investors should buy Microsoft into any material weakness.