Microsoft (NASDAQ: MSFT) was once considered a mature tech stock held for stability and earnings rather than growth. But over the past five years, Microsoft stock has jumped around 300% as a visionary CEO turned his company upside down.
Satya Nadella, who succeeded Steve Ballmer in 2014, reduced Microsoft’s reliance on Windows and Office license sales and expanded its ecosystem with a “mobile first, cloud first” mantra. Nadella ditched the company’s Windows Phone and smartphone ambitions, launched mobile versions of its apps on iOS and Android, and aggressively expanded its cloud services.
Image source: Microsoft.
This transformation initially strangled earnings growth, but it paid off as the commercial cloud business – which included Office 365, Dynamics 365 and Azure – became its new engine of growth. Microsoft has also expanded its Surface and Xbox businesses to maintain a healthy presence in the PC and gaming markets, respectively.
These strengths have supported Microsoft’s results throughout the COVID-19 crisis, and its stock has risen nearly 11% since the start of the year, even as the S&P500 slipped more than 12%. But in the longer term, will Microsoft continue to outperform the market?
Microsoft strengths
Windows accounts for nearly 80% of the desktop operating system market, according to StatCounter, while Office controls nearly 90% of the creative and email market, according to Gartner. Microsoft leveraged its dominance in both markets to turn Windows and Office into cloud-based services. Microsoft initially offered Windows 10 as a free upgrade; the addition of a cloud-based app store and updates makes it more similar to iOS and Android.
Image source: Microsoft.
Microsoft then transitioned Office users from periodic upgrades to a subscription-based model with Office 365 and extended its Dynamics CRM (customer relationship management) platform as a cloud-based service. It also extended Skype to compete Softand acquired LinkedIn to take the lead in the professional social media niche market.
To support these services and the cloud storage and processing needs of enterprise customers, Microsoft has extended its Azure cloud infrastructure platform, which now ranks second in the market after Amazon Web Services (AWS).
Azure’s market share increased from 14.6% to 17.6% between the fourth quarters of 2018 and 2019, according to Canalys, while AWS’s share increased from 33.4% to 32.4% . Microsoft also notably won the coveted $10 billion JEDI cloud contract from the Pentagon, although Amazon is trying to delay the deal with a lawsuit.
In the hardware market, Microsoft forced the laptop market to evolve with the Surface, which created a new niche of 2-in-1 devices. And it continues to challenge sony into the gaming console market with the Xbox One and expanded into the augmented reality space with HoloLens. It also wisely divested most of its display advertising business and partnered with Apple to showcase its productivity apps on iOS.
The main weaknesses of Microsoft
Microsoft’s commercial cloud revenue jumped 39% annually in its second fiscal quarter and accounted for more than a third of its revenue, but the company still faces fierce competition from manufacturers. ‘AWS and other competitors in the cloud platform market, Selling power in the cloud CRM market, and many small businesses, including Slack and Zoom — in the cloud-based collaboration market.
Microsoft’s more personal computing segment, which generated 36% of its revenue last quarter by selling Windows licenses, hardware devices, Xbox consoles and its search-based ads, also remains more exposed to macro headwinds. than its cloud business. Microsoft withdrew its guidance for the unit in late February, and it’s unclear whether growth in its cloud services can offset the slowdown.
Microsoft’s gaming revenue has also declined over the past year as customers postponed their hardware upgrades before the Xbox Series X launches in late 2020. However, Microsoft sold fewer Xbox Ones than Sony did. has sold PS4s over the past five years, and that gap could widen if Microsoft fumbles the next launch.
So how high can the stock skyrocket?
Wall Street expects Microsoft’s revenue and profit to grow 12% and 18%, respectively, this fiscal year. The stock isn’t cheap at nearly 30 times forward earnings estimates, but Microsoft’s strengths – particularly in the cloud market – arguably justify that premium valuation.
Microsoft already has a massive market capitalization of $1.33 trillion, so it may not be realistic to expect multibagger returns over the next five years. However, the stock can still climb higher, as its “mobile first, cloud first” strategy compensates for the diminishing importance of its legacy businesses.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a board member of The Motley Fool. Leo Sun owns shares of Amazon and Apple. The Motley Fool owns shares and recommends Amazon, Apple, Microsoft, Salesforce.com, Slack Technologies and Zoom Video Communications. The Motley Fool recommends Gartner and recommends the following options: January 2021 Long Calls at $85 on Microsoft, January 2021 Short Calls at $115 on Microsoft, May 2020 Short Calls at $120 on Zoom Video Communications, January Short Calls 2022 at $1,940 on Amazon and long calls January 2022 at $1,920 calls on Amazon. The Motley Fool has a disclosure policy.
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