Over the past seven years, Microsoft has transformed itself from an operating system and productivity software company into one of the worlds most valuable companies and a diversified tech juggernaut.
CHOOSING THE RIGHT STOCK
When considering an investment in any company, the Investment Thesis has to be considered within the context of three areas.
Best in Class - Microsoft Windows is the most widely used operating system for business and personal use. The company is in the top three of all of its competitive business environments. In 2021 Microsoft generated $168B in Revenue, Net Profit of $61.3B (38% growth) and returned $39.8B to shareholders in the form of buybacks ($22.9B) and dividends ($16.9B). Management has strong execution credibility and is lead by CEO Satya Nadella who started with the company in 1992 and took the helm in 2014.
Secular Growth Trend - Microsoft has positioned itself to capitalize on multiple secular growth trends simultaneously including cloud, business solutions, digitization of the global economy and gaming.
Strong Macroeconomic Environment - As of January 2023 the US economy is strong, causing the US Federal Reserve to increase interest rates. This is both a strength and a weakness. As a strength, the future is to bring technology and productivity together to improve efficiency and reduce costs which is anti-inflationary. As a weakness however, many analysts view the interest rate policy as a deliberate move to force the economy into a recession. As interest rates increase it affects the capital expenditures technology budgets of corporations.
INVESTMENT THESIS
The Investment Thesis for Microsoft is founded on three pillars
1. Diversified and Integrated product line
- Traditionally Microsoft is viewed as the Windows operating system on PC’s and Microsoft Office. Since 2014 the company has diversified its product line into a fully integrated solutions business. Microsofts Azure cloud business has 20% market share compared to Amazons 31% and Googles 6%. Microsoft offers productivity solutions through Office 365. Collaboration and communications solutions have become a focus in the digital age. Security solutions across clouds, platforms and email. Applying AI to advertising in LinkedIn and the Bing search engine. Gaming to provide next generation entertainment.
2. Recurring Revenue streams - Microsoft has diversified its revenue generation model from a ‘Licencing’ fee to a recurring revenue stream for cloud based PaaS (Platform-as-a-Service), cloud based Iaas (Infrastructure-as-a-Service) and Microsoft Azure. LinkedIn has over 750 million users which provides recurring advertising revenue. Office 365 has 42 million subscribers. The Activision Blizzard acquisition signals a move towards a Gaming-as-a-Service strategy in a $110B addressable market.
3. Digitization of the global economy - All information and data is being digitized and there is a move away from corporations maintaining their own storage systems to cloud based storage which provides increased power with user based costs. Digitization requires security. Productivity reduces costs. This process is going to evolve and accelerate in the coming years.
RISKS
Any investment or trade has to be made within the context of the risks to the Investment or Trade Thesis.
Competition - Microsoft provides integrated productivity and collaboration tools and services that work with technologies their customers already have both on-premises or in the cloud. There are other competitors that offer individual applications which are not fully integrated. Apple and Google both offer preinstalled productivity suites, Slack, Zoom and Skype offer collaboration software, videoconferencing and video communications solutions. Okta, Proofprint, and Symantec provide security solutions. LinkIn competes with recruiting companies. Microsoft Dynamics competes with cloud based solution providers such as Salesforce.com, Oracle, and SAP. Azure competes with Amazon Web Services, Google Cloud, IBM, VMWare and open source offerings. Unix and Linux operating systems are preinstalled by some providers such as Hewlett-Packard, IBM and Oracle.
Economic Environment - Rising Interest rates negatively affect the capital expenditures budgets of companies.
Cost Increases - rapidly changing consumer preferences for accessing services requires continuous investment in infrastructure and devices which increases operating costs and may negatively affect operating margins. Compensation packages to attract talented employees in a competitive labor market increases costs.
Supply Chain - Hardware is manufactured by third party providers.
Foreign exchange conversion - A large portion of revenue is generated through international operations. Increases in US dollar value negatively affects profitability
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Post Covid-19 - The pandemic accelerated a number of secular trends in the digitization of the global economy and gaming. There is uncertainty over the continued effects post pandemic.
Activision Blizzard Acquisition - Microsoft is in the process of acquiring Activision Blizzard for $69B which was valued at the height of the pandemic pricing. 2023 pricing has seen tech stock prices collapse and Microsoft may be viewed as overpaying for the acquisition.
What does all that mean at stockmarketHQ
Microsoft has transformed itself into a fully integrated software and cloud services provider. With 2021 Revenue growth of 18% and Net Profit growth of 38%, the company has an extremely strong balance sheet and has secured future income by diversifying licensing and recurring revenue streams.
Microsoft has positioned itself to capitalize on future secular growth trends in cloud computing, gaming, software and solutions by creating an integrated business and personal ecosystem. LinkedIn has over 750 million users. Office 365 has over 42 million subscribers. Artificial Intelligence will allow the Bing search engine to compete more directly with Google and Meta in the advertising space.
The most significant near term risk to the stock price is US Federal Interest Rate Policy. Regardless of the strength of a company, increasing interest rates cause big money managers to rotate funds out of technology stocks. The ideal time to invest in Microsoft is in a decreasing interest rate environment. The strongest companies will be the first to see their stock prices advance.
Tangible risks to the investment Thesis focus on two areas
1. Competition
2. Costs
Management has a strong history of managing risks and executing on their business strategy to remain a leader in all of its segments.
A shareholder friendly philosophy of returning profits to investors through share repurchases and dividends provides the foundation for large financial institutions to hold Microsoft in their long term portfolios.
The Diversified and Integrated Product Line, Recurring Revenue Streams, and Digitization of the Global Economy provide the foundation of a strong Investment Thesis for a long term, stable investment with a consistent growth trajectory for several years.
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