Microsoft is getting closer to normal historical P/E but not yet a bargain

MSFT - Microsoft

Microsoft is a leading technology company in the world, developing and supporting software, services, devices, and solutions. The company offers an array of services, including cloud-based solutions to its customers and online advertising to a global audience. Microsoft also designs, manufactures, and sells devices, including PCs, tablets, gaming consoles, other intelligent devices, and accessories.

The company has an extensive global footprint extending to more than 190 countries and runs regional operating centres worldwide. It caters to organizations of every size in every industry globally. Microsoft’s major R&D facilities are located in Redmond, Washington, and others in the U.S., Canada, China, Czech Republic, India, Ireland, Israel, and the UK. Microsoft has three business segments – Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

Microsoft offers the world’s most comprehensive cloud analytics from Azure Data Factory to Azure SQL Data Warehouse to Power BI. About 95% of the Fortune 500 trust Microsoft Azure for their mission-critical workloads. Microsoft Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built-in. The company is a popular choice among masses with Windows 10 being active on more than 900 million devices worldwide and witnessing a faster adoption across both enterprise and consumer. Office 365 Commercial has 180 million users and Outlook apps on iOS and Android also surpassed more than 100 million users. Microsoft markets and distributes its products and services through OEMs, direct, distributors and resellers.

Investment Data

Revenue Growth & Market Exposure

Microsoft’s strong customer commitment has resulted in deeper partnerships, larger, multiyear cloud agreements, and growing momentum across every layer of technology applications over the years. Microsoft’s Windows 10 is the most secure and productive operating system. Its commercial cloud business is the largest in the world, with $38 billion in revenue last year and gross margin at an impressive 63%.

Microsoft spends billions on R&D activities. The company is expecting the next phase of innovation will come from the intelligent cloud and the intelligent edge. It also has an industry leading portfolio of over 61,000 U.S. and international patents issued and over 26,000 pending. Microsoft is known for offering end-to-end security spanning identity, device endpoints, information, cloud applications, and infrastructure. The company continues to invest in data centres and other hybrid and edge infrastructure to stay ahead of the competition. It is also investing in large and growing markets to help customers transform digitally. Microsoft has become the first to open cloud data centres in the Middle East and in South Africa.

Microsoft is known for launching popular and most-loved products. Its Visual Studio and Visual Studio Code are now the most popular code-editing tools in the world and TypeScript is one of the fastest-growing programming languages. Microsoft is the recognized leader in business intelligence in the cloud, with more than 25 million models hosted on the service with Power BI. Next, the company is focusing on infusing AI across Microsoft 365 to enable new automation, prediction, translation, and insights capabilities. It also expanded the portfolio of Surface devices this year including the new Surface Go, Surface Hub 2S, new Surface Duo and Surface Neo. Deep technological expertise, a large suite of products and a strong brand recall definitely makes Microsoft an undisputed player in the technology industry.

Dividends

Microsoft is a Dividend Achiever with an impressive dividend growth streak. It has grown its dividends annually at a rate of 14%+ CAGR over the last decade and last raised its dividend payout by 23% annually. The company sports an annual average dividend yield of 1.1%, currently. Its earnings have also registered a growth rate of 13% CAGR in the last three years. Given a reasonable payout ratio of 35%, strong cash flows and growing demand for digital products and platforms, the company should comfortably continue growing its dividend at the same pace going forward.

Microsoft returned more than $30 billion to shareholders in the last year. The company generates ample cash flows from its best selling products and a substantial royalty stream from licensing its patents. Its transition to a services and subscription business model should also support clear visibility of cash flows. A strong brand recall, a large portfolio of successful products and a huge geographical reach form a massive moat around the company’s business.

Microsoft has been growing organically through innovative products and platforms and accretive acquisitions. Since its acquisition of GitHub in October 2018, growth has accelerated and it is being used by more than 40 million developers. Microsoft designs products and platforms enabling organizations to digitize physical spaces and interactions. It is expected that the number of connected devices coming online will more than double to 50 billion by 2030. The company stands a good chance to leverage its leadership position in technology and help organizations to build their own proprietary technology solutions.

Competition

The company faces intense competition from large software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application companies as well as local application developers. Its server products business also faces competition from vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle that provide pre-installed operating systems on server hardware. Microsoft ranks among the two largest providers of cloud computing at scale. Azure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, Salesforce.com, VMware, and open source offerings. Apple and Google also provide fierce competition to Microsoft’s gaming business.

Bottom Line

Microsoft has a large presence across differentiated layers of technology ranging from application infrastructure to data and artificial intelligence, to business processes, productivity and collaboration. The company stands a good chance to benefit from rapidly advancing AI and IoT capabilities, data, and knowledge. Rapid technology and product launches, ample cash flow generation and a reasonable payout ratio should support Microsoft’s dividend payment streak well in the future.

As you can see, the drop from our rocky markets is merely bringing valuation closer to the historical trend. It’s not yet a bargain but you should pay attention.

DISCLOSURE: Please note that I may have a position in one or many of the holdings listed. For a complete list of my holdings, please see my Dividend Portfolio.

DISCLAIMER: Please note that this blog post represents my opinion and not an advice/recommendation. I am not a financial adviser, I am not qualified to give financial advice. Before you buy any stocks/funds consult with a qualified financial planner. Make your investment decisions at your own risk – see my full disclaimer for more details.
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