Shareholders of Microsoft Corp. (MSFT, Financial) have been the beneficiary of an extraordinary climb in 2023, with the stock gaining more than 39% year to date.
As a result, Microsoft’s market capitalization of $2.5 trillion trails just Apple Inc.’s (AAPL, Financial) for largest in the world.
Microsoft’s stock is not cheap at more than 30 times expected earnings estimates, but the company’s performance has warranted such a valuation.
Despite the elevated multiple, there are still several reasons why owning shares of Microsoft is a good decision.
Recent earnings results are mostly encouraging
Microsoft reported fourth-quarter 2023 earnings results on July 25, with numbers coming in ahead of estimates. Revenue grew 8.3% to $56.2 billion, which easily beat analysts’ estimates by $710 million. Earnings per share of $2.69 compared favorably to $2.23 in the prior year and was 14 cents better than expected.
For fiscal year 2023, revenue grew 7%, or 11% in constant currency, to $211.9 billion. while earnings per share of $9.68 were up marginally from the prior fiscal year. However, on an adjusted basis, earnings per share improved 7%, or 12% when excluding currency exchange.
Microsoft has proven over the years that is it extremely effective at growing both its top and bottom line.
With just a few exceptions, revenue and net income have increased annually for more than a decade.
Admittedly, the most recent fiscal year growth rates are below the long-term average. The last decade has seen a compound annual growth rate of more than 10% for revenue and nearly 16% for earnings per share.
Still, quarterly results for most of the business segments were in the low to mid-teens. Productivity and Business Processes grew 10% due to high growth in Office Commercial and cloud services, while the Intelligent Cloud grew 15% on improved demand for server products and cloud services.
More Personal Computing was a headwind to results, with revenue falling 4% as gains in Xbox and Windows Commercial were offset by weaknesses in devices and Windows OEM.
Fiscal year 2023 might prove to be more of an outlier then a new trend for the company. According to analysts, revenue for fiscal year 2024 is projected to be $235.9 billion and earnings per share is expected to be $11.01, representing growth of 11.3% and 13.7% from the previous period.
Fundamentals are strong
Given the company has executed well for a long period of time, it is not surprising that Microsoft could be considered one of the most fundamentally sound names in the market place.
The company scores well in nearly every metric that GuruFocus rates, including receiving a perfect 10 out of 10 on profitability rank.
Microsoft compares very well to its competitors on most metrics in this area, often outperforming the more than the approximately 2,600 companies in the software industry. Most of the company’s scores are also near the top-end of its own long-term history.
For example, return on equity, assets and invested capital rank among the best in the industry and are at or near Microsoft’s 10-year highs.
Even in areas where Microsoft is not at the top of the peer group, the company still outshines much of the competition. For example, gross margin tops roughly three-quarters of the industry and looks strong against its own history. A gross margin of almost 69% is Microsoft’s best figure in the last decade.
Elsewhere, Microsoft’s metrics score well in a number of areas. The company receives top marks for growth and financial strength that are partially offset by weaker showings for value and momentum. However, Microsoft has a GF Score of 95 out of 100, implying the potential for outsized returns moving forward.
Cash flow generation creates a healthy balance sheet
Operating a highly profitable business should lead to a healthy balance sheet. Microsoft produces a massive amount of free cash flow, including $59.6 billion last fiscal year.
The company has not been shy to utilize its cash flow.
Acquisitions have been one such avenue of use. Most recently, Microsoft announced that it had agreed to purchase Activision Blizzard Inc. (ATVI, Financial) earlier this year for $69 billion in all cash. Regulators’ concerns have held the deal up, but both companies pushed the deadline for an agreement back to mid-October. The deal would likely be the largest ever in the gaming industry if it were to be approved and would give Microsoft an even better position in the area of gaming.
Additionally, Microsoft has retired 772 million shares of stock, or 9.3% of the share count, since fiscal year 2014. This penchant for share repurchases was apparent in the most recent reporting period, where the company bought back $5.7 billion and $22 billion of its own stock in the fourth-quarter and fiscal year, respectively.
Dividends have also been another way to use free cash flow. Microsoft has raised its dividend for 21 consecutive years, one of the longest dividend growth streaks in the technology sector. Shares yield just 0.8%, but this is not for a lack of effort on the part of the company. The dividend has a CAGR of 10% over the last decade.
The dividend looks to be very safe as well. Microsoft’s’ average payout ratio since fiscal year 2014 is 39%, but this drops to 31% when looking at just the last five years. The expected payout ratio for this fiscal year is just 24%.
Finally, Microsoft does carry a large amount of long-term debt relative to other companies, almost $60 billion, but this is down from $71 billion just three years prior.
Simply put, Microsoft creates an impressive amount of free cash flow that can be used for a multitude of purposes to improve the business and reward shareholders.
The stock is fairly valued against its intrinsic value
Even with the stock trading at 30 times forward earning, this is in the vicinity of the stock’s five-year average price-earnings ratio of 28. On a historical basis, the stock is not overly expensive.
The same holds true when considering the GF Value Line. Microsoft currently trades at $330, giving the stock a price-to-GF Value ratio of 0.98 and earning it a rating of fairly valued from GuruFocus.
Final thoughts
Microsoft has been one of the better performing stocks in 2023. While some might be looking to take profits in the name, I believe there are many reasons to continue to hold the stock. The recent business results showed most areas of the company are performing well. The fundamentals, the balance sheet and free cash flow generation are all very sound. Even the valuation, which might seem rich, is near its medium-term average and shares are rated as fairly valued against the stock’s GF Value.
Taken together, these factors appear to make the case that Microsoft is still a good long-term investment.
