Cloud software giant Microsoft (MSFT +0.17%) reported blowout earnings on Tuesday evening. Revenue accelerated an incredible 17%, a stunning rate for a $1.8 trillion behemoth, marking an acceleration over the 12% growth posted last quarter, 13.6% growth posted in the most recent fiscal year ended last June, and 14% growth in the year ended June 2019.
Many value-oriented investors will point to the law of large numbers when cautioning against investing in high-growth stocks, often scoffing at the prospect that a large company can maintain or accelerate such a growth rate. After all, if a large company runs out of market opportunities, it should slow down as it gets bigger. When that happens, a highly valued stock can experience a vicious drawdown.
However, if a growth stock can maintain its growth rate or even accelerate it, as Microsoft has, that can be a recipe for a millionaire-making stock. And Microsoft today is a prime example of how to find it, since the signs of reacceleration were there all along.
Microsoft posted reaccelerating revenue. Image source: Getty Images.
Pay attention to the different segments
When looking at any large company with several different business segments, it's important to analyze each segment underneath the hood, and not just the overall headline figures. Sure, Microsoft was growing a healthy 12%–14% rate for the past few years, but examining its segments over the past couple of years and quarters might have clued you in to the company maintaining, or even accelerating, that rate.
Back in fiscal 2019, about one and half years ago, Microsoft's segment revenue and growth looked like this:
|
Full Year 2019 (millions) |
Productivity and Business Processes |
Intelligent Cloud |
More Personal Computing |
Total |
|---|---|---|---|---|
|
Revenue |
$41,160 |
$38,985 |
$45,698 |
$125,843 |
|
Growth rate |
14.8% |
21% |
8.1% |
14% |
Data source: Microsoft June 2019 earnings release.
Back then, one might have looked at the 14% growth rate and postulated that Microsoft's growth would inevitably decelerate from there, given its massive size and $125 billion in total revenue. However, if you had analyzed each segment, you would have seen that its smallest segment, the intelligent cloud, was growing much faster than the other two segments.
In time, it was not unthinkable that intelligent cloud would surpass the other two segments in revenue. At such time, it would be larger, and thus Microsoft's overall growth rate would gravitate more toward the intelligent cloud's growth rate.
Not only that, but the intelligent cloud segment itself also had multiple segments, including the all-important Azure cloud platform, server products and cloud services, and enterprise services. At that time, Azure was growing 76%, server products and cloud services was growing 28%, and enterprise services was growing 6%.
So even within the intelligent cloud segment, one could assume the high-growth Azure platform was also smaller than the other two parts, but that over time, Azure would make up a larger portion of the intelligent cloud segment. So even if Azure were to decelerate from its lofty 76% rate, its larger size would enable the overall category to maintain or accelerate its growth rate.
The inevitable acceleration has happened
As you can see from the just-reported second fiscal quarter of fiscal 2021, Microsoft's somewhat predictable acceleration happened, as the intelligent cloud became a larger part of the mix:
|
Q2 FY 2021 (millions) |
Productivity and Business Processes |
Intelligent Cloud |
More Personal Computing |
Total |
|---|---|---|---|---|
|
Revenue |
$13,353 |
$14,601 |
$15,122 |
$43,076 |
|
Growth rate |
12.9% |
23% |
14.5% |
16.7% |
Data source: Microsoft Q2 2021 earnings release.
OK, so intelligent cloud didn't become the largest segment; however, that's only because the more personal computing segment contains the Xbox, which has thrived during the pandemic and just released its first new console in seven years during the quarter. That led to the reacceleration of the more personal computing segment as well.
Nonetheless, we can see that despite Azure decelerating to "only" 50% growth last quarter, down from the 76% in the fiscal fourth quarter of 2019, the intelligent cloud segment accelerated from 21% in fiscal year 2019 to 23% in the recent quarter, just by virtue of the fact that Azure is now a larger part of the Microsoft pie.
That has made the intelligent cloud a larger part of the Microsoft mix, propelling Microsoft's overall growth rate higher.
The big takeaway
It's often assumed that a company will inevitably decelerate as it becomes larger. However, as Microsoft has shown, some of the best investments can come from strong companies with more than one product or segment, in which the smaller segment grows at a much higher rate than the older "core" product. Often, the market may only perceive a company's overall top line and then factor that into its valuation.
However, if you can parse out a smaller segment that's growing faster, you might just have stumbled upon a stock that can maintain or even accelerate a high growth rate. And more often than not, a company that reaccelerates revenue and earnings is rewarded quite well indeed.
When looking at the next large-cap company with several segments, keep this important lesson in mind. If you find another example of a rising star segment buried beneath a more well-known and mature core segment, you might just have come upon a millionaire-making growth stock in the making.
