Microsoft: a reminder of what growth is
Microsoft released Q1 earnings this week. No, your eyes are not deceiving you.
Whilst the current earnings season is called the “Q3 season” by most people to align with the calendar year (i.e. covers the period July – September), companies with year-ends other than December won’t be calling this Q3.
Microsoft’s year-end is July, so this is a Q1 result for the 2021 financial year. What a result it was!
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Welcome to the big league
Sometimes people get annoyed when I don’t gush over a JSE mid-cap for producing 10% earnings growth. That’s an admirable result in the SA context, but luckily my money has a passport.
I can invest up to R1m a year offshore without any headaches or onerous approvals. So can you.
I would love to tell you that I’m at any risk of breaching that amount, but unfortunately I am not struggling with such a high-quality problem. So, I can invest on any global market.
Why, then, would I choose to invest in a JSE company just keeping its head above water when I can invest in Microsoft instead?
Let’s touch on just a few big league numbers…
Revenue up 12%. Operating income up 25%. Net income up 30%.
Bear in mind that the base for these numbers is enormous. This isn’t a start-up on a “hockey stick” growth journey (the famed J-curve with a slow start and then exponential growth). These growth rates are being achieved by a group worth over $1.5tn.
Oh yes, and these are growth rates on US Dollar numbers. A proper currency.
How do they do it?
The cloud business in Microsoft is smashing it. Lockdown accelerated the shift towards cloud computing for most enterprises and it’s a trend that isn’t about to reverse.
There are 45.3 million consumer subscribers for Office 365. The subscription income underpin in Microsoft is amazing.
The cloud business generated $15.2bn in just 3 months, a glorious 31% increase vs. the comparable period last year. Included in this was Azure, Microsoft’s competitor for Amazon Web Services, up 48%.
There are highlights all over the place. In terms of new products, Surface revenue was up 37%. Gaming had another strong quarter, with Xbox content and services up 30%.
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Social media has disrupted search
This is one of the most interesting trends that I’ve picked up this year.
Google is having a tough time of it at the moment and we will find out this week whether search revenue in Google has recovered. In Microsoft, search advertising revenue is down 10% but LinkedIn revenue is up 16%.
Advertisers are clearly shifting focus away from traditional search media (e.g. Google Ads) towards social media spend. Perhaps this is because social media platforms tell us what we should want based on preferences, whereas Google waits for us to ask what we want.
What about margin and cash flow?
I always focus on margin and cash flow, so it wouldn’t be right for me to ignore it here while gushing over Microsoft.
Gross margin is 70%. Seven-zero-percent. Yes, that is ridiculous. Perhaps more ridiculous is 43% operating margin.
Microsoft is a scalable, cash-generating machine of epic proportions. This margin helped Microsoft generate free cash flow of $14.4bn off a revenue number of $37.2bn. That’s a free cash flow conversion rate of just under 39%.
This allowed Microsoft to return $9.5bn to shareholders.
Strength in numbers
I really enjoy Jon Erlichman on Twitter. His Tweets are so insightful and give great context to market news.
He had three great Tweets on the Microsoft earnings that tell the story perfectly:
…and this is why I don’t waste my time or money making bets on JSE mid-caps that “may unlock a value discount in the multiple” – there’s a big world out there of companies like Microsoft instead.
With JSE opportunities, I only invest where I have high conviction that it will go well. Obviously I get it wrong from time to time, but chasing marginal companies in a country like South Africa just doesn’t sit well with me.
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