Cramer's Investing Club: Microsoft's strong earnings report further confirms why we own the stock

Published Tue, Jan 25 20227:51 PM ESTUpdated Tue, Jan 25 20227:58 PM EST

Microsoft (MSFT) reported on Tuesday better-than-expected earnings and revenue for its fiscal second quarter of 2022. On the top line, total revenue of $51.7 billion (+20% YoY) exceeded the consensus estimate on FactSet of $50.711 billion. Microsoft's profitability looked stronger than anticipated as well, with 67% gross margins (flat YoY) edging estimates of 66.65%, and 42.9% operating margins (+1% YoY) was a big beat against the 41.24% estimate. On the bottom line, Microsoft earnings per share of $2.48 (+22% YoY) exceeded estimates of $2.31. Before digging into the various operating segments, let's take a quick look at some of the important companywide performance metrics. Commercial business on a tear Commercial bookings growth accelerated to 37% YoY on a constant currency (CC) basis, from 14% last quarter. The company's commercial remaining performance obligation, defined as the "commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods" grew to $147 billion from $137 billion in the fiscal first quarter. Commercial revenue annuity ticked lower sequentially to 94% but was up one point YoY as user workloads continue to shift toward the cloud. Microsoft cloud revenue increased to $22.1 billion (+32% YoY CC) and Microsoft cloud gross margin came in at 70%, a tick down from the prior quarter and one year ago. As for some other financial highlights, operating expenses increased 14% YoY to $12.5 billion as the company continues to invest in cloud engineering, gaming, LinkedIn, and commercial sales. Capital expenditures to support the growth in Microsoft's cloud offerings came in at $6.8 billion, higher than the $5.955 billion the Street was looking for. And while we consider Microsoft to be a cash flow generating machine, the higher capex spend weighed on free cash flow, which only grew 3% YoY, to $8.6 billion, and missed estimates of about $10 billion. Capital Allocation Microsoft returned $10.9 (+9% YoY) billion to shareholders in the quarter, with $6.2 billion coming via buybacks nd the remaining $4.7 billion from dividends. Although the dividend yield isn't as meaningful as it once was due to the stock's big stretch of outperformance over the past handful of years, we always have an appreciation for companies that annually raise its dividends and buy back stock and Microsoft does just that. Operating Segments Moving on to the various operating segments, starting with Productivity and Business Processes, revenue of $15.94 billion (+19% YoY CC) edged the $15.877 billion consensus while operating income of $7.69 billion (+24% YoY CC) exceeded expectations of $7.515 billion. Within the segment, Office Commercial products and cloud services revenue increased 14% YoY CC as Office 365 Commercial seats grew 16% YoY. Office consumer products and cloud services revenue grew 15% YoY CC with Microsoft 365 Consumer subscribers increasing to 56.4 million, up from 54.1 million in the prior quarter Dynamics products and cloud services revenue advanced 29% YoY CC, while Dynamics 365 revenue surged 44% YoY CC thanks to a 161% increase from Power Apps. Finally, revenue at LinkedIn, a clear beneficiary of a tight labor market, increased 36% YoY CC as LinkedIn sessions grew 22% with record engagement. In the Intelligent Cloud, revenue of $18.33 billion (+26% YoY CC) edged the $18.312 billion estimate, while operating income of $8.20 billion (+37% YoY CC) was higher than expectations of $8.079 billion. Digging into the segment, server products and cloud services revenue grew 29% YoY CC. Keep in mind that the one number that arguably matters more than any other single metric in the eyes of Wall Street is Azure and other cloud services revenue growth, which checked in this quarter at +46% YoY. We believe this number is being nitpicked in after-hours trading tonight because even though Azure growth exceeded the street estimate of about 45%, the "whisper number" may have been a couple percentage points higher. Furthermore, Azure revenue growth decelerated about 200 basis points from the fiscal first quarter's growth rate of 48%. Some may call this is a slowdown, but we believe that to be a false narrative and it is more a result of the law of large numbers. And as we learned in next quarter's guidance (more below) management expects to see strong growth in Azure next quarter. Elsewhere within the segment, Enterprise Services revenue increased 8% YoY CC, server products revenue grew 6%, and the enterprise mobility installed base grew 28% to over 209 million seats. Personal Computing sales outperform Lastly, PC sales hit $17.47 billion (+15% YoY CC), nicely outpacing the $16.618 billion estimate, while operating income of $6.36 billion (+21% YoY CC) was a big beat over estimates of $5.384 billion. Driving the segment, Windows OEM revenue surged 25% YoY thanks to growth in the PC market, especially in commercial with higher revenue per licenses. Windows commercial products and cloud services revenue grew 14% YoY CC. Surface revenue return to growth and increased 8% YoY, driven by sales of the Surface Laptop. Search and news advertising revenue excluding traffic acquisition costs (TAC) increased 32% YoY CC with improved customer advertising spend In gaming, total revenues increased 8% with Xbox content and services revenues up 10% YoY thanks to growth in first-party titles and Game Pass subscriptions, which is now over 25 million across PC and console. We can't wait to see what Microsoft does with GamePass next after its acquisition of ActivisonBlizzard goes through. Xbox hardware revenues increased 3% YoY CC as Microsoft continues to see strong demand for the Xbox Series X/S. The only thing holding back console sales right now is supply constraints. Guidance When considering guidance, you must always remember that management doesn't provide until the conference call, at the end of their prepared remarks. And without that guidance, you can't make a full judgment of the quarter. That's one reason to always listen to the earnings call before acting on a stock. Segment revenue guidance was as follows: Productivity and Business Processes: $15.6 to $15.85 billion, which at a midpoint of $15.73 billion is in line with estimates of $15.758 billion. Intelligent Cloud: $18.75 to $19 billion, representing a beat even at the low end relative to consensus estimates of $18.562 billion. Importantly, management expects Azure revenue growth to be up sequentially in constant currencyThis should allay any fears of a slowdown in the cloud and that too much demand was pulled forward by the pandemic More Personal Computing: $14.15 billion to $14.45 billion, a beat versus the $13.652 billion estimate Adding that all up, we get a total revenue guide of $48.5 billion to $49.3 billion which at a midpoint of $48.9 billion is nicely higher than estimates of $48.113 billion. On the other side of the income statement, management guided for COGS (cost of goods sold) between $15.5 billion and $15.7 billion, slightly above the $15.208 billion on the Street but understandable given the higher-than-expected revenue guidance. Total operating expense is expected to be $13.4 to $13.5 billion. For the full year, management now sees full margins being slightly up YoY, an improvement from their prior outlook of down. Our take A great quarter from Microsoft and an even stronger outlook that confirms the broader thesis we outlined earlier Tuesday . Now that we know Microsoft's business is still performing at a very high level and no signs of a slowdown in sight, what we have to figure out next is at what price does it make sense to buy the stock? With MSFT down about 15% from its high as of today's close and currently trading at about 29x CY 2022 earnings estimates—that will likely be revised higher to reflect the strong guide—we think anywhere from today's close of $288 to the after-hours jump to $296 represents a good price to either start a new position or add to an existing one. But brace yourselves. One good quarter from Microsoft does not mean the volatility in the market is over just yet. As we have seen over the past month, no company is immune to broader market pressure. So as we would say with almost any buy, it's always important to leave room to scale in deeper at potentially lower prices just in case the market has different plans. (Jim Cramer's Charitable Trust is long MSFT. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Satya Nadella, chief executive officer of Microsoft Corp., spe