Microsoft Corporation (MSFT) Is Still Not Overvalued Despite Earnings Miss

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Microsoft Corporation (NASDAQ:MSFT) probably suffered the worst day in the stock market on April 22. The reason was very simple, its earnings missed by two cents and revenue by a whisker. Does that warrant a dragging of more than 7% on a single day to trade below the 50-day moving average price? Also, does it mean that the stock has become overvalued suddenly or because of the earnings miss? In the preceding three quarters, its earnings provided positive surprise by 9.9%, 13.6%, and 7.10% respectively. Therefore, one earnings miss cannot be termed as if the valuation is stretched. However, it is a fact that all the positive work done by the management was put behind because of the very reason. The valuation is based on future earnings, and if that is taken into consideration, the stock is still available cheap only and not overvalued. The recent sell-off could also be regarded as buying opportunities.

Reason For Earnings Miss

Microsoft Corporation (NASDAQ:MSFT) continues to do well if some operational performance were into consideration. One of the main reasons that the company’s earnings suffered was due to the increased tax rate. Originally, the company guided only 20% at the time of the second quarter earnings announcement. However, the actual rate of tax was 5.4 percentage points more than the guidance rate, which means 25.4%. Also, it is the same case in respect of non-GAAP earnings too. The adjusted tax rate also worked out four percentage points higher than the guided one.

The possibility of the Microsoft Corporation (NASDAQ:MSFT)’s earnings topping the expectations if the tax rate remained in the guided range was certainly there. For instance, only 74.6% of the profit or 76% adjusted profit was available for EPS calculation. The difference between the guided and the actual range is 4 – 5.4%. Based on a simple calculation of 4% adding to the delivered adjusted EPS, it would have meant 64.4 cents if the tax is on the guided rate. That would have been in line with the expectations. Therefore, it was not the performance of the company but the tax rate that remained a big part of earnings missing the expectations. That also strengthened the argument that the valuation is not stretched and the stock cannot be regarded as Over-valued one.

Operational Performance

It is a fact that Microsoft Corporation (NASDAQ:MSFT) would not be able to generate the same kind of licensing revenue given the fact that it has allowed its Windows 10 free download. Therefore, the company delivering revenues from the productivity and business processes higher by 1% driven by each category be it cloud or dynamic products or officer consumer or office commercial was not an easy task. Its presence in the cloud space continued to be strong with its Azure demonstrating 120% YOY growth in revenue though intelligent cloud services advanced 3%.

As far as Microsoft Corporation (NASDAQ:MSFT)’s personal computing division, it showed growth of 1%, which was also better considering the weak sentiments prevailing on the PC segment. However, its Surface provided a significant growth of 61%, which is a positive factor and the company’s efforts to focus on high-end utilization to compete with the MAC is going on in the right direction. The segment is not as big as the PC and remains smaller. However, its advancement in the segment is a key factor for growth ambitions. The company is now focused on boosting the adoption rate of its Windows 10 to one billion before the end of the year 2018. There were already indications that its adoption rate came close to 250 million users. The adoption rate is quicker than any of its previous OS.

Windows Phone

Microsoft Corporation (NASDAQ:MSFT) witnessed 46% YOY drop in unit shipment of its Windows phone. It might not have been a surprise considering that it was not demonstrating any big shift in the smartphone sales performance. However, the same cannot be said anymore. There is a potential for it with its new Windows 10, and it was bound to take advantage of it. Recently, Forbes reported about leaks of the company’s Surface Phone, which would be a high-end specification and got a big boost. The report termed the device as ‘supercar-styled smartphone’. The focus is also clear that the company wants to reinvent itself in the mobile space with the help of Windows 10 and not to boost the adoption rate of the OS.

The key point here is that whatever Microsoft Corporation (NASDAQ:MSFT) did so far on the smartphone side did not provide the expected results. That cast the shadow on the performance in its third quarter also. However, that will change in the coming quarters with the new launch of a smartphone. For that purpose, the company gave away the habit of pricing it lower than the rest. The company is now placing the smartphone along with the others in the ‘best of class’ device category. There is a hope that this smartphone will do better than its previous models as it would be clubbed along with the other Surface products. For instance, its Surface Book has given the buyer another option and is now leading the design charge ahead of the MacBook. However, it might not be able to outbid iPhone, but can provide better results than what it did until now.

Significant Available Cash

After Apple Inc. (NASDAQ:AAPL), one of the few companies to have over $100 billion of cash is Microsoft Corporation (NASDAQ:MSFT). This should allow them to return more cash to its shareholders. Currently, it pays a dividend of 36 cents a share and it will pay the same rate one more time. After that, another hike can be expected as the last ten years witnessed continuous dividend increase. The company also bought back more than $3.7 billion shares in the third quarter.

Conclusion

Microsoft Corporation (NASDAQ:MSFT) enjoys forward PE ratio of 17.78 times compared to the industry averages of 31.8 times in the last trailing twelve-month period. The new ecosystem in the OS should also help it in the long-run as the company is focusing on reaching one billion. The company also increases its dividend rate and provided a solid yield of nearly 3% or more. Therefore, it is still worth buying after the Friday’s sell-off.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Viraj Shah

Viraj Shah has completed M.Com (Finance) and is currently pursuing his CFP. He tracks US markets along with other global markets like India very closely. He is very passionate about stocks, real estate, and technology. He also believes that money can always be made in the market.

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