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Technology giant Microsoft (NASDAQ: MSFT) unveiled better-than-expected quarterly earnings after the market close Thursday. The stock popped 5% in early trading on Friday and finished up 5.8% for the day.
It’s been a prolonged rally for Microsoft stock. Shares are up more than 30% in the past year, while the S&P 500 index is down 5% in that time.
It was only a few years ago that Microsoft stock was relegated to “dead money” status, due to the perceived overreliance on the personal computer, which some view as a dying industry. Microsoft has proven it has succeeded in its efforts to expand into higher-growth value drivers, and the stock has rewarded patient investors who held on.
Earnings Handily Beat Expectations
Last quarter, Microsoft earned an adjusted $0.78 per share, which exceeded Wall Street estimates by 7 cents. Non-GAAP revenue came in at $25.7 billion, ahead of the $25.26 billion projected by analysts.
On a year-over-year basis, the results don’t look great. Total revenue and earnings per share declined 10% and 12%, respectively, versus the same quarter last year. The strengthening U.S. dollar played a major role – constant-currency revenue and operating profit grew 3% and 13%, respectively.
Microsoft ended the quarter in top-notch financial shape. It ended 2015 with $102 billion in cash and short-term investments on its balance sheet, compared with $42 billion in short-term liabilities. Its long-term debt to equity ratio is a comfortable 53%. Microsoft remains one of just three U.S. companies to hold the triple-A credit rating from Standard & Poor’s.
Cloud Growth
It’s been widely known for some time that the personal computer industry is in trouble. As an increasing amount of computing functions are being performed on mobile devices and smartphones – at both the retail and enterprise levels – PC sales are slowing down.
This is affecting Microsoft’s core software business. Last quarter, Microsoft saw further erosion in its Windows OEM business. Revenue declined 5% in constant currency in that area. Fortunately, Microsoft was wise enough to see the writing on the wall several years ago and began to invest aggressively in cloud capabilities. Those investments are now paying off.
Microsoft’s cloud-based offerings like Azure and Office 365 are showing huge growth. Last quarter, Office 365 revenue surged 70% year-over-year, and it now has more than 20 million subscribers. Dynamics revenue grew 11%. Revenue from Azure soared 140% for the quarter.
Separately, Microsoft is also doing well in hardware. Surface revenue increased 29% year-over-year, driven by strong sales of the Surface Pro 4 and Surface Book. Monthly active users for its Xbox Live service rose 30% year-over-year to a record 48 million, once again indicating strong sales of the Xbox One video game console.
The Bottom Line
After such strong performance, Microsoft shares aren’t as cheap as they were a year ago. The stock trades for 20 times forward earnings estimates, which is the most expensive it has been on a forward P/E basis in the last five years.
The key question is whether Microsoft’s growth momentum can sustain its valuation. It appears the answer is yes, especially if some of the headwinds that have held the company back, such as foreign exchange, can show improvement over the next year.
In the meantime, Microsoft remains in excellent financial condition with an ironclad balance sheet. And the stock offers a nice 2.5% dividend yield.
While Microsoft stock probably can’t be considered a screaming bargain like it once was, it is still a great company.
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