The largest company in the world by market cap is reporting earnings Wednesday, October 23rd, after the bell in one of the most anticipated September quarter releases. Investors and traders have driven MSFT up over 36% this year. Microsoft MSFT ostensibly represents the cloud and software industry in the US, and it is booming. Microsoft analysts have big expectations for its September quarter (fiscal Q1) results.
Zacks Consensus estimate consists of an EPS of $1.25 on revenues of $32.23 billion, which would represent year-over-year growth of 10% and 11%, respectively. MSFT is not typically a big mover on earnings but has had a positive price impacts following earnings for the past 8 consecutive quarters, averaging a 2.2% upside.
Microsoft has transitioned its topline to one that is primarily subscription-based, a business model that is being utilized across the tech sector. Their primary revenue drivers are subscription-based Microsoft Office, Microsoft Windows as well as on-premise server products, but cloud computing is the future of this firm.
Microsoft’s new cloud computing technology, Azure, has investors in a frenzy attempting to value this proliferating segment. Since Azure was initially launched back in 2011, this company’s forward P/E has more than doubled as investors evaluate the potential of this new technology.
Corporations across the world are quickly shifting from on-premise servers to less costly and more easily accessible cloud computing. Amazon’s AWS launched 13 years ago and has proven the cloud computing business model. Today AWS makes up more than 50% of this almost trillion-dollar online retailer’s profits.
Azure has seen triple-digit to high double-digit growth figures since it gained traction back in 2015. These growth rates far outpace that of AWS, and the rest of the commercial cloud space as Azure takes progressively more market share. Microsoft’s commercial cloud revenue just took the cloud crown from Amazon, and at its current growth rate, I don’t see MSFT being usurped any time soon. The main concern that investors have with this segment is its ability to turn a profit. At Azures comparable stage in adaptation, AWS had already attained operating profit margins north of 20%.
As Azure scales, the margins should expand, but the competition in the space is a concern. The cloud computing sector is becoming increasingly saturated. Competitive pricing is likely going to continue to pinch margins. Top competitors include Google GOOGL, IBM IBM, and previously discussed Amazon AMZN.
Despite MSFT’s size, it has continued to produce double-digit topline growth and expanding margins. Microsoft’s growth is being driven primarily by Azure, Office Commercial, and LinkedIn. The company has a dedicated 13% of the firm’s revenues to R&D so that Microsoft can continue to stay ahead of the curve. The firm is expected to drive double-digit top and bottom-line for the next two years.
MSFT is trading on the higher side of its 5-year forward P/E trends, but this is in line with the growth of the software sector, which has been propelled by cloud capabilities. Some analysts are worried that the space is trading at an unsustainable multiple and that margin contraction may occur at the current 25.5x forward P/E. MSFT’s 1.5% dividend gives me some comfort with its current valuation.
Microsoft is the global leader in software and cloud computing. It will continue to set the standard for both of these categories and pave the way for the 4th revolution.
MSFT will most likely beat on both top and bottom-line estimates. Look for progression in the cloud segment as well as any changes in forward guidance as these may be a catalyst for movement in MSFT’s price. This earnings report could have an impact on the entire cloud space.
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