Tech giant Microsoft (NASDAQ: MSFT) is on a tear. The stock has returned over 25% in the past one year, including share price returns and dividends, and has significantly outperformed the market in the past 12 months.
The reason that Microsoft stock has rallied in that time, and could continue to outperform going forward, is that it has engineered a hugely successful transition away from the personal computer. Formerly known as a lumbering giant chained to the slowing PC market, Microsoft is now a growth company, thanks to its huge growth from the cloud.
Continued growth in new areas could set the stage for Microsoft stock to continue beating the market over the next year.
Microsoft Has Its Head in the Cloud
One of the most notable changes to come along in the tech sector over the past few years is the deterioration of the PC and the ensuing smartphone boom. Consumers are steadily gravitating towards smartphones, both at home and at work. Industry research company IDC reports that worldwide PC shipments declined 4% last quarter, and IDC forecasts another annual decline this year.
Microsoft has been caught squarely in the cross-hairs of this technological shift, but fortunately the company has responded by expanding into the cloud to keep up with the trends. It was only a few years ago that Microsoft was considered “dead money” because of its reliance on the PC, but all that has changed.
Microsoft is generating significant contributions from its cloud-based Office 365 and Azure software products.
The company is still reliant on the PC in large part, but not nearly as much as it used to be. While Microsoft’s revenue fell 2% in fiscal 2016, it saw strong growth across many of its other core businesses.
On an annualized basis, Microsoft’s commercial cloud operation is now a $12 billion business by revenue.
It has seen very positive momentum this fiscal year. Office 365 commercial revenue soared nearly 60% last quarter, year over year. In the same period, revenue from Azure jumped more than 100%.
Furthermore, Microsoft’s other products are doing well, and are helping to offset the weak PC industry. Surface revenue grew 9% last quarter as Microsoft’s tablets have latched on with consumers. Its console hardware is also very popular with gamers. Last quarter, Xbox Live subscriptions rose 33%.
Future growth will be generated not just by its cloud products and services, but by expansion into new businesses. Microsoft’s recent $26 billion acquisition of LinkedIn (NASDAQ: LNKD) offers the potential for significant growth in professional networking. Microsoft should be able to meaningfully expand its scale with LinkedIn’s 430 million users.
Lots of Cash on Hand
Microsoft is seeing excellent growth across a number of its key businesses, and the stock remains a compelling value given its prodigious free cash flow and rock-solid balance sheet.
Microsoft raked in $25 billion of free cash flow in the last fiscal year, which was up 5% year over year. Such strong levels of cash flow have left Microsoft with a balance sheet stuffed with cash.
As of last quarter, Microsoft had $113 billion in cash and equivalents. This is cash that far exceeds the company’s debt, and can be used to invest in growing the business going forward, or returning cash to shareholders through stock buybacks and dividends.
Microsoft has a ‘AAA’ credit rating with Standard & Poor’s.
Microsoft Dividend and Growth
And, the stock is attractively valued. Microsoft trades for a forward P/E of 18, which is about on par with the S&P 500. But given Microsoft’s excellent cash flow and balance sheet, it deserves an above-average valuation.
Plus, Microsoft is a great dividend growth stock. The current Microsoft dividend yield is 2.5%, which is above the average dividend yield in the S&P 500, and Microsoft typically raises its dividend at high rates. Last year, the Microsoft dividend was increased by 16%. Going forward, it should continue its pace of double-digit dividend hikes, given its strong fundamentals.
As a result, Microsoft has something to offer nearly all investors—growth, value, and dividend income.