Microsoft Corporation (MSFT) Q2 Earnings Preview

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Microsoft Corporation (NASDAQ: MSFT ) stock has had an impressive run over the past few years. Heading into Thursday's fiscal second quarter earnings report, MSFT stock is right near an all-time high, having increased about 150% over the past few years.

Should Bill Gates Sell His Microsoft Corporation (MSFT) Stock?

Source: Via Microsoft

What's interesting about the gains for such a large stock - MSFT is the third-most valuable company on U.S. markets, behind only Apple Inc. (NASDAQ: AAPL ) and Alphabet Inc (NASDAQ: GOOGL ) - is that they haven't been based on Microsoft earnings. Microsoft's EPS was $2.73 in fiscal 2012, and $2.79 in fiscal 2016.

Rather, the multiple investors assign to MSFT stock has expanded. It has more than doubled, in fact.

That multiple expansion has come from increasing confidence toward Microsoft's future earnings potential, most notably in mobile and cloud. Where investors four to five years ago saw a fading giant whose earnings were likely to decline, Microsoft now looks like a sleeping giant. And investors clearly believe the company's self-described "mobile first, cloud first" strategy is going to push Microsoft earnings up - at some point.

It's in that context that the market will analyze the Microsoft earnings report due on Thursday.

Microsoft's Growth Isn't There…Yet

It's always dangerous for an investor to believe that the numbers don't matter, but in the case of MSFT stock, the numbers really aren't the most important thing right now.

Analyst consensus - informed in large part by Microsoft earnings guidance - doesn't predict a particularly impressive second quarter earnings report. The Street expects EPS to rise just a penny year-over-year, which given share repurchases, implies that Microsoft's total net profits actually will be lower in Q2 FY17 than they were ago. Revenue is estimated to fall almost 2% year-over-year.

Microsoft's guidance projects growth in its Productivity & Business and Intelligent Cloud segments, but a sharp decline in More Personal Computing.

That shouldn't be surprising. Office 365 growth has helped business revenue, and the Azure platform continues to be a worthy, if still much smaller, competitor to Amazon Web Services in cloud. It's the potential for success in those products that has offset fears about continuing pressure on revenue from Windows, as PC sales decline and mobile usage increases.

Indeed, the gain in MSFT stock from $27 to $63 has come mostly from the transition.

The fears of Windows losses that led MSFT stock to be valued around 10x EPS in 2013 have turned to optimism toward growth in Azure, Office 365, Enterprise Mobility and other areas. That optimism has pushed the same stock to be valued at about 21x FY17 earnings.

So it seems unlikely that investors will focus on the major headline numbers coming out of the Microsoft earnings report. A beat or miss of a penny or two on earnings likely isn't going to drive the market's reaction to the report - particularly if that weakness comes from Windows. Rather, the focus is going to be on the growing, smaller, businesses, most notably Azure.

There's a reason Microsoft has steadily expanded its disclosure around Azure and cloud growth: That's where investor attention has been. And it seems likely that's where investor attention will stay coming out of the Q2 Microsoft earnings report.

What to Watch For in Microsoft Earnings

Investors seem likely to have some patience with a modest miss in the Microsoft earnings report, as expectations remain relatively low. The company still is getting out from under its deal with Nokia Corp (ADR) (NYSE: NOK ), and layoffs this year should provide a boost to margins over the next few quarters. Wall Street in particular isn't expecting growth to pick up until fiscal 2018, where sales are projected to grow more than 6% against a rate under 2% in fiscal 2017.

So what seems to be important in the Q2 Microsoft earnings report is whether the base of that growth is intact.

While Azure is estimated to generate just 3% of total revenue, according to analyst firm MKM Partners, its growth rate certainly will be watched closely. After a 140% increase in Q2 FY16, and 116% last quarter, any slowdown seems likely to hurt the stock. But another 100%-plus figure would give further evidence that Azure is a worthy competitor to AWS, and support the current MSFT stock price.

The cloud business as a whole - including Office 365 and Dynamics, which is trying to take share from, Inc. (NYSE: CRM ) - will be another area of post-earnings analysis.

What does that mean for Microsoft stock coming out of the Microsoft earnings report?

Overall, it means that the quarter seems likely to be judged more on "feel" than on the hard numbers. Even though cloud and mobile still aren't the majority of MSFT revenue or earnings, they are the cornerstones of the Microsoft strategy going forward. And for now, it's relatively clear that the market is content to wait for those sales and profits - as long as it continues to trust in that strategy.

If Microsoft can deliver another earnings report that shows growth is on the horizon, MSFT stock likely will rise - even if the headline numbers aren't perfect. But if there's any sort of stumble in either cloud or mobile, that investor patience could reverse - quickly.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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