Is Microsoft Destined for Greatness?

What makes a stock great? Some investors seek growth, and some covet steady dividends, but nearly everyone agrees that a great stock should consistently beat the Street year after year without getting ahead of its fundamentals and risking a meltdown.

The best stocks don't just beat the market, they do so sustainably, with improving financial metrics that support strong price growth. Let's take a look at what Microsoft's (Nasdaq: MSFT  ) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell Microsoft's story, and we'll be grading the quality of that story in several ways.

Growth is important on both the top and bottom lines, and an improving profit margin is a great sign that a company's become more efficient over time. We'll also look at how much Microsoft's free cash flow has grown in comparison with its net income.

A company that generates more earnings per share over time, regardless of the number of shares outstanding, is heading in the right direction. If Microsoft's share price has kept pace with its earnings growth, that's another good sign that it can continue higher.

Is Microsoft managing its resources well? A company's return on equity should be heading higher, and its debt-to-equity ratio declining, if it's to earn our approval.

Healthy dividends are always welcome, so we'll make sure Microsoft's dividend payouts are increasing, but at a level that can be sustained by its free cash flow.

Now, let's take a look at Microsoft's key statistics:

MSFT Total Return Price Chart

MSFT Total Return Price data by YCharts
 

Criteria (3-Year Results)

Result

Grade

Revenue Growth > 30% 26.2% Fail
Improving Profit Margin (111.7%) Fail
Free Cash Flow Growth > Net Income Growth 84.2% vs. 16.5% Pass
Improving Earnings per Share 23.5% Pass
Stock Growth (+ 15%) < EPS Growth 37% vs. 23.5% Pass

Source: YCharts.

MSFT Return on Equity Chart

MSFT Return on Equity data by YCharts
 

Criteria (3-Year Results)

Result

Grade

Improving Return on Equity (33.2%) Fail
Declining Debt to Equity 23.9% Fail
Dividend Growth > 25% 53.9% Pass
Free Cash Flow Payout Ratio < 50% 21.8% Pass

Source: YCharts.

How we got here and where we're going
Microsoft earns a reasonable score, with five out of nine passing grades. As it works through its massive $6.2 billion writeoff of a failed online ad-serving acquisition, Microsoft's bottom line will undoubtedly recover -- unless Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) fend off its mobile beachhead.

CEO Steve Ballmer gave us all an "inside scoop" on Microsoft's future ambitions recently, so let's quickly highlight his thoughts, which undoubtedly paint a bullish picture:

  • Windows 8 will be as important to Microsoft as was Windows 95.
  • Surface tablets will not be bargain-basement devices and are more likely to compete with Apple's iPads than Amazon.com's (Nasdaq: AMZN  ) Kindles, which are now sold in multiple versions over a much broader price-point spectrum.
  • Microsoft wants to be a devices-and-services company.

Windows 8 is a big part of Microsoft's future, and the comparison seems fair. This is the first time Microsoft's tried to build an operating system across multiple platforms, and its ability to create a unified ecosystem will probably be critical to its success against Apple and Google in mobile. Neither company boasts the installed base of Windows-compatible PCs. However, Google's gobbling up an ever-larger share of the booming smartphone market and could soon have Microsoft-style scale in the post-PC era.

Microsoft's partnership with Nokia (NYSE: NOK  ) should be far more important to its near-term mobile ambitions. The Lumia 920 reveal and its premium pricing didn't wow analysts, but you can always think like a contrarian and expect consumers to be bowled over by a phone that finally offers something fresh after years of a de facto Apple-Google smartphone duopoly. Being a contrarian has its advantages, but a keen eye on sales numbers and consumer reviews will be important if you're to stay on top of the trends.

Putting the pieces together
Microsoft has some of the qualities that make up a great stock, but no stock is truly perfect. These numbers are likely to change over time, so it's vital to keep track of Microsoft's progress. The Fool is here to help with our new premium research service. When you subscribe to our Microsoft reports, you'll get updates, for a full year, every time we uncover important news or develop deeper analysis. Click here to subscribe today.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter, @TMFBiggles, for more news and insights.

The Motley Fool owns shares of Google, Apple, Microsoft, and Amazon.com. Motley Fool newsletter services have recommended buying shares of Google, Apple, Amazon.com, and Microsoft, as well as creating a synthetic covered call position in and a bull call spread position in Apple. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 29, 2012, at 1:14 PM, chastenruin wrote:

    I see the complete opposite for Microsoft. Their best position is in the desktop, which is decreasing in sales year by year as more mobile devices come online. Their position in mobile is anemic, less then 5% penetration even after running Nokia like a puppet government to flood the market with phones people dont want to buy.

    The X-Box is a bright spot and a sore spot all at the same time. The consoles lose money themselves, but they are making it up in the market share they were able to carve out and the software they sell. However now these same mobile devices are beginning to cut into the console market, especially from the development side and the need of software companies to generate profits. When you are shipping 15M consoles versus 500M smartphones per year, you tell me where the momentum for software development is going to trend.

    Probably the brightest spot looking forward has nothing to do with the console itself, but the CONTENT NETWORK attached to it. X-Box Live is a viable product for content of all types to be pushed from the cloud to the devices of the world. That's really the only bright spot for growth in Microsofts future.

    Right now Microsoft is living off the fat of Windows and Office licenses. But those sales are going to start declining as the desktops decline. They will be paying large sums of money to develop, then ultimate sell at a discount, the Surface in order to gain market share because they are desperate for a position in mobile. That is not a position of strength, they completely missed the boat and Android and iOS control a staggering 95%+ of the mobile market. To top it off, they will have 2 versions of mobile OS's for 2 different processor types, expecting developers to now code for 2 different platforms on top of Android and iOS.

    The Surface is going to stay on the shelf. And cost billions.

    Microsoft is a dinosaur headed for the tar pit. XBox Live is the brightest spot in their future, but can they leverage it to be a Netflix or Amazon Plus for all devices, or will they just stay proprietary?

  • Report this Comment On September 29, 2012, at 8:03 PM, NickD wrote:

    Yea well Apple is Doomed!!! because the lost their leader.

  • Report this Comment On September 30, 2012, at 2:42 PM, chastenruin wrote:

    The difference between Apple and Microsoft is Apple has successfully diversified where Microsoft has fallen on its face every time it tries to diversify. Outside of the XBox, most of their attempts to develop other devices and products has been a miserable failure.

    Apple has the highest sales per square foot of any retailer in the world, as well as selling the most music online, has the leading brand of smartphone, digital music player and tablet, and is the #1 reseller of independent software in the world with the App store. Apple has successfully moved away from being just a computer company and is now a consumer device juggernaut.

    They release products and industries adapt because of it. Companies go bankrupt in their wake. To say they are doomed is a little short-sighted, they still have products in the pipeline that go after other portions of the electronics industry like TV sales. Apple is still the best hardware/software integrator on the planet, largely a result of having complete control over the development of both sides of the product when building a new device. This alone puts them in a position of strength over device manufacturers that have to license their OS from other vendors and have no control over its inner workings.

    Is Apple going to make some mistakes? Sure, but lets be realistic here, they have to distance themselves from Google and the Maps problem is not as big of a deal as its hyped up to be.

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