It doesn’t seem too long ago that Microsoft (NASDAQ: MSFT) stock was routinely referred to as “dead money.” Shares had stagnated for many years in the aftermath of the bursting of the tech bubble.
The thinking was that Microsoft did not have enough opportunities for growth. It was supposedly too reliant on the personal computer, which was on its way out.
The critics were wrong: Microsoft has come roaring back. The stock has increased more than 120% in the past five years, not including returns from dividends. Microsoft’s major rally has been due to the company’s resurgence under CEO Satya Nadella.
Microsoft emerged from its former identity as just a PC company through massive growth of its cloud-computing business. It has also had renewed success in tablets and gaming. Microsoft is still an attractive stock, even after its huge run-up.
Microsoft Cloud at the Heart of Growth
Microsoft’s recent fiscal third-quarter earnings report delivered good news overall. Revenue and earnings per share increased 6% and 16%, respectively, from the same quarter last year. Excluding the impact of foreign exchange translations, Microsoft generated 19% earnings growth for the quarter.
Microsoft’s quarterly earnings beat expectations, while revenue came up slightly short. The company missed on revenue, largely due to weak phone and tablet sales. But Microsoft should see stronger growth rates in its tablets business, once its new Surface model hits store shelves.
More importantly, Microsoft’s core software businesses are successfully transitioning to the cloud. Microsoft is racking up huge growth from cloud computing. Office 365 grew 45% for the quarter. Other Microsoft cloud based offerings, Dynamics 365 and Azure, saw 81% and 93% growth, respectively.
These segments drove revenue in the Productivity and Business Practices segment up 22%, to $8 billion. And, revenue in Intelligent Cloud was $6.8 billion, an 11% increase from last year. Overall, Microsoft’s commercial cloud platform has now exceeded a $15 billion revenue run rate.
Looking ahead, Microsoft believes it will continue to see steady growth. Management forecasts $7.2 billion-$7.4 billion in Intelligent Cloud segment revenue for the current fiscal quarter. This would represent as much as 10% growth, year over year.
Microsoft Stock is Pricey But Attractive
There could be an argument made that Microsoft stock is pricey. At nearly $70 per share, Microsoft stock trades for a price to earnings ratio of 30, which isn’t exactly cheap. However, the company should continue to generate enough growth to justify its current valuation.
In addition, Microsoft remains a fantastic dividend growth stock. In the past five years, it has raised its dividend by 15% on average, each year. The stock has a current dividend yield of 2.3%, which is higher than the average dividend yield of the S&P 500 Index.
Microsoft can raise its dividend at such high rates because its business is a cash cow. Microsoft generated $9 billion of free cash flow last quarter, up 11% from the same quarter in 2016. Through the first nine months of the current fiscal year, Microsoft generated $23 billion of free cash flow. It paid $9 billion in dividends during this time.
And, don’t forget about Microsoft’s tremendous balance sheet. It’s sitting on a gold mine: Microsoft ended last quarter with $126 billion in cash and marketable securities, which represents nearly one-quarter of its market capitalization.
Its pristine balance sheet allows the company to earn a ‘AAA’ credit rating from Standard & Poor’s. It is only one of two U.S. companies to receive S&P’s highest credit rating.
Huge Cash Flow, High Dividend Growth
Microsoft stock has had a tremendous run for a prolonged period, which could keep potential investors on the sidelines. But to avoid Microsoft, or consider selling on valuation, would be a mistake. The company continues to grow, thanks to its investments in cloud products and services.
And, Microsoft generates a huge amount of cash flow. It has a balance sheet loaded with cash. Plus, the stock offers investors an above-average dividend yield along with high dividend growth each year. These are margins of safety that will help cushion a downturn.