Microsoft (MSFT +0.06%) was once considered a slow-growth tech stock. But over the past five years, its stock nearly quadrupled as CEO Satya Nadella's "mobile first, cloud first" strategy paid off.
Microsoft's business also remained resilient through the pandemic this year, as the growth of its cloud, gaming, and consumer-oriented businesses -- which all benefited from remote work and stay-at-home measures -- offset the weaker growth of its enterprise-facing ones.
Investors might be tempted to take some profits after that multi-year rally since Microsoft's stock now looks historically expensive at 33 times forward earnings. But before cashing out, investors should realize that three catalysts could still generate fresh growth next year.
Microsoft CEO Satya Nadella. Image source: Microsoft.
1. The expanding Xbox ecosystem
Microsoft launched its new consoles -- the Xbox Series X and the less powerful, digital-only Series S -- in November. Both consoles reportedly sold well during the holiday shopping season, especially as stay-at-home measures spark stronger demand for new video games.
Microsoft only sold about 49 million Xbox One consoles over the past seven years, putting it behind Sony's (SNE +2.08%) shipments of 115 million PS4s and Nintendo's (NTDOY 1.30%) shipments of 74 million Switches.
But Microsoft plans to close that gap in the new console generation with three main strategies. First, it's selling the Series S for just $300, which matches the Switch's price and is $100 cheaper than Sony's PS5 Digital Edition. That lower price point could attract more gamers.
Second, Microsoft's Xbox Game Pass, a subscription plan that serves unlimited downloads of over 100 games, already has over 15 million subscribers. Microsoft recently introduced a new tier, Game Pass Ultimate, that bundles together Game Pass, Xbox Live Gold, and the new Xbox Cloud Gaming service for $15 a month. That premium tier, along with Microsoft's cheaper consoles, could significantly expand its gaming ecosystem.
Lastly, Microsoft recently acquired ZeniMax, which owns hit franchises like Fallout, Doom, and The Elder Scrolls, and added its games to Xbox Game Pass. Microsoft will also likely launch some of ZeniMax's future games as Xbox exclusives -- which would widen its moat and help it keep pace with Sony and Nintendo's first-party titles.
All those strategies could strengthen Microsoft's gaming business, which generated 8% of its revenue in fiscal 2020 (which ended on June 30).
2. The growth of its "commercial cloud" business
The pandemic generated strong tailwinds for many cloud companies in 2020. Remote workers relied heavily on cloud-based services to stay connected, and companies ramped up their usage of cloud infrastructure services to keep their businesses online.
That's why Microsoft's "commercial cloud" revenue, which mainly comes from Office 365, its cloud platform Azure, and its Dynamics CRM (customer relationship management) platform, grew 36% to over $50 billion (or more than a third of its top line) in fiscal 2020.
Image source: Getty Images.
That momentum continued in the first quarter of 2021, as its commercial cloud revenue increased another 31% year over year to $15.2 billion. The segment's core growth engine is Azure, which ranks second in the cloud platform market after Amazon (AMZN +3.49%) Web Services (AWS).
Between the third quarters of 2019 and 2020, Azure's global share of the cloud market grew from 17% to 19%, according to Canalys. AWS' share dipped from 33% to 32%. Azure won't catch up to AWS anytime soon, but it should continue growing at a faster rate while attracting more partners (especially brick-and-mortar retailers) that don't want to feed Amazon's most profitable business.
Investors should expect Microsoft's commercial cloud business to remain its core growth engine in 2021, and new partnerships could buoy its growth even as it faces tough year over year comparisons to the pandemic.
3. An acceleration in enterprise spending
The pandemic mainly affected Microsoft's Productivity and Business Processes segment -- which houses Office, Dynamics, its enterprise network LinkedIn, and its server-based software. The unit's revenue grew 13% in fiscal 2020 and accounted for nearly a third of Microsoft's top line. But that marked a deceleration from its 15% growth in 2019, mainly due to sluggish enterprise spending during the pandemic's darkest days in its fourth quarter.
The unit's revenue rose 11% year over year in the first quarter of 2021, which topped its own expectations with the robust growth of LinkedIn and the consumer versions of Office. Dynamics also continued growing and kept pace with the broader expansion of the CRM market.
If the pandemic passes next year, the unit's weaker enterprise-facing businesses (such as Office Commercial) should firm up again as businesses resume their spending. That acceleration would fix Microsoft's weakest link and complement the ongoing growth of its other businesses.
The key takeaways
Analysts expect Microsoft's revenue and earnings to rise by 11% and 17%, respectively, this year. Those are impressive growth rates for a 45-year-old company, and they indicate that Nadella's "mobile first, cloud first" mantra continues to modernize Microsoft and reduce its dependence on legacy technologies like desktop software and locally installed operating systems.
Microsoft's stock might not seem like a bargain right now, but its strengths arguably justify its higher valuation. The stock might not replicate its multibagger gains anytime soon, but it remains a solid long-term investment for 2021 and beyond.
