The stock, at around $45, is up 21% on the year to date, more-than doubling the tech sector's 9% gain. But investors are nervous about the company's Tuesday earnings, and not for the usual reasons.
The approval rating of new CEO Satya Nadella continues to rise and it's not hard to understand why. Since Microsoft reported its financial results in April -- Nadella's first as CEO -- the company has added roughly $31 billion to its market cap. As long as that trend continues, investors will prolong their applause.
What's more, unlike when Steve Ballmer was at the helm, Microsoft is finally getting the benefit of the doubt from Wall Street analysts it never enjoyed before. Nadella wants to turn Microsoft back into a growth company and there's now a sense that the right decisions will be made.
Although the company's dominant Windows and Office franchises continue to score the lion's share of Microsoft's revenue, Nadella is working to develop new, fast-growing businesses to lessen Microsoft's dependency on PCs.
These are still relatively small segments like commercial cloud service, Office 365 and the company's cloud platform Azure. Each of these businesses are growing revenue at a rate of over 100%. Equally and perhaps more impressive, gross margin in this segment is 25%, up roughly 7% year over year. That suggests Microsoft is making money in these areas.
Can this continue?
After having already dominated Microsoft in the consumer segment with iPhones and iPads, Apple's CEO Tim Cook has landed a credible partner to help him attack Microsoft in the enterprise business. Combined, Apple and IBM plan to develop iPhone and iPad apps and provide on-site support to IBM’s business customers worldwide.
If Apple and IBM are successful at synergizing their businesses, the financial impact on Microsoft and other enterprise/cloud companies such as Oracle (ORCL) and Hewlett-Packard (HPQ) can be severe. Not to mention, IBM's application support of iPhones may cause observers to second-guess Microsoft's phone ambitions and the company's decision to buy Nokia's (NOK) handset business.
Microsoft is planning to cut 18,000 jobs as a way of eliminating overlapping functions and duplication. This, too, is going to require attention. Nokia's phone business was losing money each quarter prior to the acquisition. Still, Nadella has been confident that he can grow Microsoft's phone market share and turn a profit. Given the stock's performance, investors are betting that he'll be right.
No one saw once-hated rivals Apple and IBM coming together. The enterprise is now up for grabs. Will Nadella strike a similar deal with, say, Google (GOOGL)? Given BlackBerry's (BBRY) strong enterprise position, perhaps Nadella should take a trip to Canada.
He's going to have some decisions to make. With nearly $66 billion in net cash on the balance sheet, he has plenty of firepower to take some risks and even miss on a few.
The good news is Microsoft stock is trading at its 52-week high, Nadella has already executed his hardest task, which is to change the market's perception of what Microsoft is and what it can be. Since his arrival, Microsoft has been a money-maker.
At the time of publication, the author was long Apple.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
TheStreet Ratings team rates MICROSOFT CORP as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:
"We rate MICROSOFT CORP (MSFT) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, notable return on equity, reasonable valuation levels, solid stock price performance and good cash flow from operations. We feel these strengths outweigh the fact that the company has had sub par growth in net income."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- MSFT's debt-to-equity ratio is very low at 0.26 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Along with this, the company maintains a quick ratio of 3.01, which clearly demonstrates the ability to cover short-term cash needs.
- The return on equity has improved slightly when compared to the same quarter one year prior. This can be construed as a modest strength in the organization. When compared to other companies in the Software industry and the overall market, MICROSOFT CORP's return on equity exceeds that of the industry average and significantly exceeds that of the S&P 500.
- Looking at where the stock is today compared to one year ago, we find that it is not only higher, but it has also clearly outperformed the rise in the S&P 500 over the same period, despite the company's weak earnings results. Turning our attention to the future direction of the stock, it goes without saying that even the best stocks can fall in an overall down market. However, in any other environment, this stock still has good upside potential despite the fact that it has already risen in the past year.
- MICROSOFT CORP's earnings per share declined by 5.5% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, MICROSOFT CORP increased its bottom line by earning $2.60 versus $2.00 in the prior year. This year, the market expects an improvement in earnings ($2.70 versus $2.60).
- You can view the full analysis from the report here: MSFT Ratings Report