Home Investment Microsoft Is an Outstanding 'Boring' Investment – TheStreet.com

Microsoft Is an Outstanding 'Boring' Investment – TheStreet.com

9 min read

George Soros counsels that good investing is boring. If that’s the case, then Microsoft (MSFT) makes for a compelling investment. The software giant is well-diversified and growing steadily, with few thrills along the way. 

Cloud Wars

Microsoft’s ambitions to be the dominant cloud player are set to become increasingly challenging, as the amount of specialization required from customers is causing this space to become ever more fragmented.

Alas for investors, determining which cloud service provider leads the race is a frightfully cumbersome endeavor, as companies report their figures very differently. Nevertheless, industry reports generally put Amazon’s (AMZN) AWS as the leader, with Microsoft’s Azure as the solid number two. The third spot goes to IBM (IBM) Cloud and then come Alphabet’s (GOOGL) Google Cloud Platform and Alibaba (BABA) Cloud.

Furthermore, as is widely known, Amazon had the incredible foresight to recognize the opportunity years ahead of any other tech-giant and set about defining the sector. However, as history demonstrates time and time again, first mover advantage is not always all that meaningful. You can think of internet search engines, mobile phones, cars, social media (MySpace). First player advantage is expensive. Yet, Amazon’s entrepreneurial spirit got AWS off the ground, and for now, it is still the leader.

While IBM moved slowly, once it recognized both the opportunity at hand and that it was dramatically falling behind, IBM went out and in a knee-jerk move, deployed a third of its market cap at the time and bought Red Hat for $34 billion in October 2018.

Accordingly, IBM’s knowledge of this space, combined with its inability to develop this all-encompassing platform in-house, goes to show just how grueling developing a hybrid cloud can be.

Thus, although Azure was developed years after AWS, Azure’s convenience and reliability allow it is to continually take market share in this space. Finally, as an added bonus for Microsoft, Azure is able to take advantage of its existing distribution system to get its software into the hands of end users.

High Margins

As noted above, each company reports different metrics for their cloud businesses. Whereas Amazon is arguably the most transparent, AWS’s operating income margin comes in at less than 30% for 2018. On the other hand, while Microsoft does not itemize its key business units, it does disclose in its SEC filings that its very high gross profit margins continue to benefit from Azure.

Microsoft grew its Intelligent Cloud revenue by 24% in its December quarter, with Azure continuing to grow its top-line by more than 75% year-over-year. Microsoft’s trailing twelve months carry a consolidated operating margin of 32.8%, suggesting that Azure’s margin could be meaningfully higher than Amazon’s crown jewel.

Valuation – Meaningfully Undervalued

At first glance, Microsoft shares appear to be fully priced, particularly when compared with its historical valuation. Specifically, at a P/Cash Flow from operations of 19.3x, Microsoft appears to be inflated relative to its historical valuation of 15.6x. However, this superficial analysis misses two critical points.

First, Microsoft’s balance sheet finished Q2 2019 with more than $125 billion of cash and equivalents, which makes its year-end 2014 balance of $86 billion look small in comparison. Thus, Microsoft’s financial position is meaningfully stronger than at any point over the past five years.

Secondly, Microsoft today is substantially better diversified than it has been historically. And although Microsoft’s Productivity and Business Processes segment generates slightly more profit than its other segments, it has less near-term growth potential than its Intelligent Cloud segment.

Final Words

Azure is more than a platform — it’s a brand that companies trust. Not only is the cloud market growing rapidly, but the sector’s runway is very long, with years if not decades of growth ahead. And most importantly, investing in a diversified giant like Microsoft leaves investors with a huge margin of safety.

Microsoft, Amazon and Alphabet are holdings in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells these stocks? Learn more now.

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