Microsoft (MSFT -2.45%) stock surged higher after reporting earnings for its fiscal third quarter on Tuesday. The software giant has not escaped the effects of the sell-off that has hit its industry or the uncertainty surrounding its metaverse strategy.
Nonetheless, its key role in the cloud and other parts of the software industry has made it one of the world's largest, most powerful companies. Hence, even with its challenges, investors should not write off Microsoft without taking a closer look at the company.
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The Microsoft conglomerate
Microsoft originally built the company on its dominance in PC operating systems. But with the decline in the PC's importance, it pivoted to cloud computing with Azure under CEO Satya Nadella. Azure is the most prominent challenger to Amazon's AWS and encompasses over 200 products and services. This change in strategy made it possible to reach a $2 trillion market cap, making it the second-largest company trading on U.S. exchanges next to Apple.
Considering the reach of Microsoft's businesses, one has to describe this company as more of a software and tech conglomerate. While best known for Azure and Windows, other software offerings include Office 365, LinkedIn, and Windows Server. It also derives revenue from hardware products such as Microsoft Surface and Xbox.
A more recent move into the metaverse seemed to hinge primarily on buying Activision Blizzard. That move has received some pushback from the Federal Trade Commission, casting doubts over the deal, valued at just under $69 billion. While Microsoft will probably succeed on some level in the metaverse, it may have to pursue a different strategy.
The state of Microsoft stock
This business boosted Microsoft's strong financial performance. In the first three quarters of its 2022 fiscal year, it generated over $146 billion in revenue, a 20% increase compared with the first nine months of fiscal 2021, including a 46% jump for Azure. Also, net income during the first nine months of fiscal 2022 was $56 billion, 25% more than the same period in fiscal 2021.
Amid a massive sell-off in many tech stocks, this performance may explain why Microsoft has experienced a more modest stock price decline than many of its peers. It has fallen about 23% from its 52-week high, so Microsoft has technically entered a bear market. Nonetheless, the growth stock-oriented Ark Innovation ETF has lost more than half of its value in the same time frame.
Also, such earnings growth makes Microsoft appear reasonable at 30.76 times earnings. That means its earnings multiple is only modestly higher than Apple's 26.30 earnings multiple and well below Amazon's 43.07 P/E ratio.
Furthermore, when looking more closely at stocks that are cash cows, Microsoft remains among the strongest cash flow generators. It generated over $47 billion in free cash flow in the first nine months of fiscal 2022, a 19% increase versus the same time frame the year before. Between that level of cash flow and its $105 billion in cash holdings, it can afford to make deals like the Activision Blizzard purchase and others in the future.
Sizing up Microsoft
The recent earnings report indicates that the negativity surrounding Microsoft is probably overdone. Yes, the Activision Blizzard deal is in jeopardy, leaving some uncertainty about the company's metaverse strategy. But with the company's considerable cash position, it will likely come up with an alternate strategy.
In the end, the massive growth in Azure and low valuation relative to its growth bode well for Microsoft's continuing prosperity.
