Microsoft ( MSFT -1.97% ) has crushed the market in recent years. But can its stock continue to deliver strong gains? Read on to find out.
Visionary leadership and strong competitive positioning
Microsoft's stock has more than tripled in value since Satya Nadella took over as CEO on Feb. 4, 2014. Yet even more impressive than these gains is the manner in which Nadella has positioned Microsoft to compete and win in a mobile- and cloud-based world.
Under Nadella's leadership, Microsoft ceded a battle it couldn't win in mobile operating systems to Google and Apple. By doing so, he freed the company to make its popular Office productivity suite available on platforms that were once rivals. That's led to renewed growth for the venerable franchise, with Office 365 commercial revenue jumping 38% in the fourth quarter.
Nadella also helped to move Microsoft more aggressively into the cloud. The company has become a powerful force in the cloud-computing arena, second only to Amazon (NASDAQ: AMZN) Web Services in the fast-growing cloud infrastructure market.
In addition, Microsoft has strengthened its ties to the increasingly important global developer community, and its recent acquisition of GitHub could help to further improve its standing in this area.
Speaking of acquisitions, Microsoft's $26 billion purchase of LinkedIn in 2016 is widely regarded as a success. LinkedIn has helped to strengthen Microsoft's Dynamics 365 enterprise customer relationship management software, thereby making it a formidable competitor to salesforce.com in the $70 billion global CRM market. The acquisition also added a valuable network of more than 575 million LinkedIn members to Microsoft's overall user base.
With so many ways to win, Nadella has built Microsoft into a force to be reckoned with once again.
Massive growth opportunities
Even as an $840 billion enterprise, Microsoft has long runways for growth still ahead. The worldwide public cloud services market will grow to more than $300 billion by 2021, up from $153.5 billion in 2017, according to Gartner. That leaves plenty of expansion potential for Microsoft, whose Intelligent Cloud segment generated $32 billion in revenue in fiscal 2018. Moreover, Microsoft continues to gain share versus current market leader Amazon, so it's likely that Microsoft's cloud revenue will grow at an even faster rate than the market as a whole during this time.
Microsoft also stands to benefit from the surging growth of the artificial intelligence industry, which is projected to increase at about 37% annually to more than $191 billion by 2024, according to Market Research Engine. Gartner is even more optimistic; the research company believes AI can help to create nearly $4 trillion in business value by 2022. Microsoft is investing aggressively in AI technology and has become a leader in this important, emerging field. In turn, Microsoft is well positioned to profit as artificial intelligence is embraced by the global economy in the coming decade.
Microsoft is also poised to benefit from the global growth of video games and esports, via its Xbox gaming system and services. Microsoft's gaming revenue surpassed $10 billion for the first time in fiscal 2018, including a 39% surge in the fourth quarter. That figure should continue to grow larger in 2019 and beyond.
With so many aspects of its business performing well, Microsoft -- even at its current massive size -- still has tremendous opportunities for growth.
Bountiful cash flow and capital returns
Microsoft's strong operational performance has also helped the company become a financial powerhouse. With more than $45 billion in net cash, Microsoft has built a fortress-like balance sheet -- one that's continuously strengthened by the more than $30 billion in free cash flow it produces on an annual basis.
Better still, this robust cash production allows Microsoft to reward its shareholders with a rising dividend income stream. The company has raised its cash payout a dozen times since initiating a dividend in 2004, and its shares currently yield a respectable 1.5%. With dividend payments accounting for only about 40% of its free cash flow, investors can expect more dividend increases in the years ahead.
A great business at a fair price
At a forward price-to-earnings ratio of nearly 23, Microsoft is trading at a bit of a premium to its 12.4% projected earnings growth rate over the next five years. Yet Microsoft is well worth its current price. Its strong competitive positioning within multiple high-growth markets should allow it to expand its profits at above-average rates for many years to come. In addition, its strong free-cash-flow generation and fortress-like balance sheet help to reduce the stock's risk profile while also supplying the cash necessary to support a growing dividend income stream for investors.
For these reasons, I'd argue that Microsoft's stock is a solid buy -- and investors who purchase shares today should be well rewarded over the years ahead.