Just as Apple (NASDAQ: AAPL)previously reached the pinnacle of a $1 trillion market capitalization, Microsoft (NASDAQ: MSFT) stock is poised to do the same. Microsoft stock can not only get to the $1 trillion mark, as Apple did, but also retain it, which AAPL failed to do.
MSFT is better diversified than Apple, and the valuation of MSFT stock, which has a price-earnings ratio of 28, is still compelling. The question is: what fundamental strengths does Microsoft have that will enable it to keep growing its revenue and profits, enabling Microsoft stock to rise further?
Microsoft to Challenge Amazon Web Services
As Barrons reported, Microsoft’s Azure, the company’s cloud business, is closing the functionality and usability gap between itself and Amazon.com’s (NASDAQ: AMZN) cloud unit, AWS (Amazon Web Services).
Azure is providing AWS with tough competition. At Microsoft’s Build event this year, it spent a significant amount of time touting Azure. It also talked about its Windows operating system and its Surface tablet hardware.
MSFT’s comments about Azure suggest the unit’s profit margins will rise going forward. Cloud services and software solutions typically are more profitable than hardware products. So, if Microsoft can meaningfully raise Azure’s market share from its current 13.7% level, the company’s profits could increase significantly, boosting Microsoft stock in the process.
Azure’s Compelling Features
Azure is a true hybrid, hyper-scale cloud solution. Customers get a consistent development environment, whether or not they are connected to the public cloud. Azure Stack extends that hybrid differentiation to allow customers to build and run cloud applications at the edge of their networks. And this feature, unlike VMWare ‘s(NYSE: VMW) offering, allows customers to build and run virtualized applications on-premise.
Moreover, Microsoft expanded the IT security capabilities of Azure by offering Azure Sentinel, which analyzes security signals across the entire organization. The solution uses artificial intelligence to detect, investigate, and respond rapidly to threats.
In MSFT’s fiscal third quarter, an increase in the number of larger, long-term Azure contracts helped MSFT grow its bookings by 20% year-over-year. The company’s Commercial Cloud revenue jumped 41% YoY to more than $9.6 billion.
Azure’s revenue grew 73%, driven by strong growth in its consumption-based business across all of its customer segments.
The Outlook of Azure
MSFT forecast that the gross margin of its commercial cloud business would continue to be high. However, that could be offset slightly by a higher mix of IaaS (infrastructure-as-a-service) and PaaS (platform-as-a-service).
One thing is certain: MSFT is making positive changes to both the hardware and software used by Azure. As a result, more customers will use premium Azure services, pushing Azure’s gross margin higher and providing a positive catalyst to Microsoft stock.
Valuation and the Bottom Line on MSFT Stock
Both Alibaba Group (NYSE: BABA) and MSFT compete with Amazon.com’s AWS, but neither BABA nor Microsoft stock has a similar valuation to AMZN stock. In relative terms, BABA and MSFT stock trade at significantly lower price-earnings multiples than Amazon.com.
Even though markets value Microsoft’s Azure at a discount, that may change. And when Azure’s revenue becomes the biggest part of Microsoft’s business,Microsoft stock is sure to trade at or above the $1 trillion level. With Azure growing so fast, that could happen very soon.
As of this writing, the author did not hold a position in any of the aforementioned securities.