Microsoft Looks Stronger Than Ever

Microsoft is at the top of its game, generating tons of cash and showing no signs of slowing down.
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Microsoft’s  (MSFT) - Get Report performance in the past twelve months has been nothing short of remarkable. The stock is up more than 65% compared with the S&P500, which is up just 21% over the same time period.

This cash generating machine is growing impressively, returning huge sums to shareholders and remaining very reasonably priced. Investors would do well to consider this stock. Here’s why:

Microsoft’s Untouchable Moat 

Certain companies offer such great products that consumers wish to have them --think, for example, of Tesla or Apple. 

Then there are companies were enterprises simply have to have in order to remain productive and efficient. Put another way, how many enterprises would be willing to spend time and resources to educate their workforce to use something new and different, aside from a trusted Microsoft one?

Azure's figures demonstrate enterprises' eagerness to adopt its platform with Q2 2020 reporting growth of 64% compared with the same period a year ago. Even though we do not know just how big Azure is, we do know that Microsoft’s Intelligent Cloud segment (Azure is part of this segment) was up 28%, reaching $11.8 billion.

Notwithstanding being a latecomer to the cloud sector, particularly when compared with Amazon’s  (AMZN) - Get Report AWS, today a markedly different landscape exists, one where the price of Azure's platform does not even enter into the discussion when enterprises come to adopt Azure.

One of the Highest Margin Companies in the World

To state that Microsoft’s operating margins often hit the mid-30s percent does not do Microsoft’s margins justice. However, if we note that these are clean GAAP margins, we get somewhat closer to demonstrating the quality of Microsoft's business.

Furthermore, unlike many tech companies that heavily capitalize their costs, Microsoft does not employ this accounting scheme. 

In fact, even after factoring in its capex requirements, it still makes 30 cents on each dollar of revenue -- again, after all costs and expenditures are accounted for.

Consequently, given how much free cash flow Microsoft makes on each dollar of revenue, it is no wonder that Microsoft's balance sheet has bulged to $74 billion of net cash.

For Q2 2020 Microsoft returned $8.5 billion to shareholders via share repurchases and dividends, which approximates 73% of its consolidated net income. Hence, we can see that the vast majority of Microsoft’s net income is being returned to shareholders.

Valuation – Large Margin of Safety

Microsoft Peer Group Comparison graphic

The table above notes Microsoft's peers’ cash flows from operations. This ratio does not factor in any stock-based compensation or capex requirements. It's a gross number that indicates broadly how investors are pricing the companies' respective cash flows.

What this superficial number does not reflect, however,  is Microsoft’s diverse operations. 

For example, whereas Apple to a large extent is contingent on selling customers a single expensive product – the iPhone generates approximately 60% of Apple’s revenues – Microsoft does not have this concern given its broad diversification.

Furthermore, whereas Apple’s business model is contingent on not only successfully pricing its products, but manufacturing products that are cutting edge, and trending, and motivate customers to make repeat purchases. Whereas for Microsoft, these risks are not even a consideration.

Switching costs for enterprises are prohibitively expensive. Microsoft could increase its prices and few would seek out something different. 

The Bottom Line

In short, Microsoft is at the top of its game and shows no signs of slowing down. As a result, it's well worth consideration by investors. 

Microsoft is a holding in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells MSFT? Learn more now.