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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:
Criteria (3-Year Results)
|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|
Criteria (3-Year Results)
|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|
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.