Think This Tech Giant is Washed Up? You Could Miss Out on Big Returns

Mac or PC user? The answer used to almost be a given. According to Asymco research, in 2004, Windows machines sold 50 times more than Macs. By 2011, this number dropped to around 20 times.

Due to heavy adoption of Macs and tablets, recent PC sales have sagged even further. According to research firm International Data Corporation (IDC), PC shipments worldwide plummeted a record 14% during the first quarter of 2013.

Microsoft (NASDAQ: MSFT), the world’s largest software company, may be in part to blame. According to IDC, Microsoft’s unintuitive Windows 8 software — which relies heavily on a touch-screen interface — was a factor in weak PC sales.

Yet, despite this news, Microsoft’s stock has been on a tear over the past few weeks.

#-ad_banner-#

So, what’s going on? If PC sales are on the decline and the company’s software is such a flop, what’s fuelling Microsoft’s growth?

To answer this question, traders must first realize that Microsoft isn’t exclusively a software company. Rather, it’s a well-diversified tech behemoth, with products ranging from the Surface tablet to the Xbox game console.

In recent years, Microsoft has expanded far beyond its Windows platform. In fact, the company has launched into the cloud. Microsoft’s Office 365 is the company’s cloud-based version of its Office suite. The software is targeted at enterprise rather than individual customers. The majority of clients using the software sign three-year, multi-million-dollar licensing agreements.

As a result, Microsoft CFO Peter Klein says Office 365 has a “$1 billion annual run rate.” Analysts at Forbes expect Microsoft Office 365 will continue to gain traction among business clients, helping drive growth well into the future.

Microsoft’s Windows Server division is also contributing to the company’s growth. This unit — which houses the SQL and Windows server tools — makes up 22% of Microsoft’s total value. As the second largest division of Microsoft (behind only software), is also one of the fastest growing.

In the most recently reported fiscal third-quarter, revenue from SQL servers and Windows Servers increased 11%. As more companies rely on big data analytics — a growing trend in which data patterns are extracted to uncover hidden patterns, unknown correlations and other useful information — growth in the server division will likely continue.

As people move from desktop computers to tablets, Microsoft is moving on, too. Earlier this year, Microsoft launched two larger-sized tablets under the brand name, Surface. Recently, management announced the Surface RT tablet will be available in 29 countries. By the end of June, the company’s more powerful Surface Pro model will be sold in 24 new markets.

Microsoft plans to release a line of smaller 7-inch Windows-powered touch-screen devices to compete with tablets like Apple’s (NASDAQ: AAPL) iPad Mini and Amazon.com’s (NASDAQ: AMZN) Kindle Fire. Microsoft’s foray into the tablet market should further help drive the company’s growth.

Microsoft also has a growing entertainment division, led by its Xbox game console. Due to a strong rise in Xbox 360 sales, the company’s entertainment division revenue increased 56% in the fiscal third quarter.

According to Microsoft, more than 46 million worldwide members use the Xbox live service, an 18% increase from the comparable year-ago period. To capitalize on this consumer growth, the company plans to release a new, upgraded Xbox console in mid-May. Future Xbox sales will likely help spur additional growth for Microsoft.

Based on these potential growth drivers, the company’s fundamental outlook looks optimistic, as do its technicals.

MSFT Chart

The stock recently broke a major downtrend line, formed off the early 2012 high, near $32. Since January 2013, shares have been on a strong uptrend. During the April 15 trading week, the stock spiked about 4% on better-than-expected earnings news.

This week, shares were up more than 7% by Thursday’s close, before pulling back slightly on Friday, as they struggle with important overhead resistance near $32. This level was established in early 2012 when shares formed a double-top, with highs in March and April.
 
If the $32 resistance level can be decisively broken, MSFT could re-approach the $35 range, a level not seen since 2007. On strong momentum, the stock could potentially even challenge its 2000 peak near $44 (adjusted for splits).

The upbeat technical outlook is supported by solid fundamentals. On April 18, the company reported record fiscal third-quarter results. Revenue for the period rose 18% to $20.5 billion. Earnings for the quarter came in at $0.72 per share, ahead of the $0.68 analysts projected.

Looking ahead to the fiscal fourth quarter and full 2013 year (ended in June), analysts project revenue will increase 17% and 7%, respectively. They anticipate fiscal fourth-quarter revenue will rise to $21 billion, from $18 billion in the comparable year-earlier period. Revenue for the full 2013 fiscal year is anticipated to be $79 billion, compared to $74 billion last year.

The earnings outlook is similar. For the fiscal fourth quarter, analysts expect earnings will increase 13.4% to $0.76 per share, from $0.67 in the year-ago period. For the full 2013 fiscal year, analysts expect a marginal earnings increase around 1% to $2.76 per share, from $2.73 last year.

In addition to a strong outlook, the company pays an annual dividend of $0.92 per share, which offers an attractive forward annual yield of about 3%. This dividend is only likely to go up in the future. Since 2005, management has consistently increased the dividend.

Risks to consider: PC sales are down, Windows 8 was a flop and computer users are moving from desktops to tablets. For Microsoft to keep up with consumer demand, it must innovate and adequately tune into consumer desires.

However, the company appears to be morphing its business model from individual, or personal computer users, to enterprise users — who are willing to pay for multi-million dollar cloud-based software and server systems. Microsoft’s focus on larger-scale clients, along with its innovative product pipeline, should continue to drive growth well into the future.

Recommended Trade Setup:

— Buy MSFT at $32 or above
— Set stop-loss at $26.03, slightly below current support
— Set initial price target at $41.10 for a potential 28% gain by late 2013