Microsoft (MSFT +2.11%) has found its coolness again. A company that seemed to be a sluggish, reactionary tech company just a few years ago now seems to have positive momentum under its new CEO Satya Nadella. And investors over the previous month have been treated to a nice 15% gain, trailing Apple but outperforming Google and the greater S&P 500 during that period.
Obviously we as long-term investors know better than evaluating a company by price performance alone, and we shouldn't look at a mere month as well, but when you consider Microsoft has outperformed the S&P 500's return by two times in 2014 -- 32% versus 10% -- investors should ask if the fundamentals are changing. And while on the surface (pun intended) it doesn't appear there's been significant changes, Microsoft is actually transitioning under Nadella.
Their devices still have room for improvement
If you are looking for improvement in Microsoft's devices, you're going to be disappointed. Although the segment is reporting higher revenue this year, that's due to the release of its Xbox One and won't be replicated in upcoming releases. The device's popularity? It is far behind Sony's PlayStation 4 in terms of units sold. The initial choices to make the Kinect peripheral mandatory had a lot to do with it initially falling behind Sony's unit due to cost and privacy concerns. Microsoft later relented on both issues, but still finds itself behind Sony in terms of console sales.
And that's actually one of Microsoft's device success stories. Its foray into tablets with its Surface line has been a disaster so far; the $900 million Surface RT writedown is credited for the loss of former CEO Steve Ballmer's job. And while the company specifically mentioned the Surface line posted a positive gross margin in the September quarter, third-party estimates figure the company has lost $1.6 billion on the product.
Finally, the company doubled down on its Windows Phone by buying Nokia for $7.2 billion. TMicrosoft hoped the acquisition would enable the company to respond to changes in the marketplace more efficiently and to compete with Google's Android and Apple's iOS. And the result has been somewhat of a mixed bag, although the company reported selling 9.3 million Lumia phone shipments, Microsoft still finds its market share stuck in neutral and even falling in Windows-phone friendly Europe.
However, devices aren't where investors should be looking
Microsoft's well-received quarter was less about devices and more about its commercial segments. Led by an excellent 9.5% increase in commercial revenue overall, and an enterprise cloud revenue increase of 128%, the company reported total revenue of $23.2 billion compared to $22 billion analyst estimates. Earlier, Nadella modified Ballmer's characterization of Microsoft as a "devices and services" company to a "mobile first, cloud first" company to emphasize its cloud prospects.
This quarter, Nadella delivered on his promises much more effectively than Ballmer had in recent memory. So for analysts and fans alike, this signifies a better-ran organization than the one in years past. And that's why Microsoft has gotten back its mojo without significant improvement in devices. Overall, the company has a large runway for growth without improvement from its Windows Phone, the Xbox One, or the Surface line of tablets.
In recent news, Microsoft has been defined by unfavorable comparisons to Google and Apple; it seemed as if Steve Ballmer was resigned to be an also-ran in the mobile market. Nadella's moves in the cloud will allow the company to focus on what it does best and should be watched closely. For investors looking for a high-yielding, cash-flow producing investment with a runway for growth, Microsoft should be on your radar.
