As financial markets have rebounded in 2019, so have shares of now-cloud giant Microsoft (NASDAQ:MSFT). Owing to its operational stability, lack of any prominent headwinds, and robust exposure to secular growth tailwinds in the cloud market, MSFT stock was largely insulated from the late 2018 market sell-off.
Until December. Then, markets fell off a cliff. So did MSFT stock. In just a few weeks, it spiraled from $112 to $94.
Since then, it’s been nothing but up, up and away for MSFT stock. The shares rebounded back above $100 by the end of the year. They cruised past $110 by February and by April, sailed above $120. All together, MSFT stock has rebounded 30% over the past few months to trade at fresh all-time highs today.
Q3 Numbers Will Be Gut Check
This rally is about to get a gut check. Microsoft reports third quarter numbers next week. Considering how far and how fast Microsoft stock has come over the past few months, the company needs these numbers to be good in order for the stock to hold onto its year-to-date gains.
Will the numbers be good? I think so. Everything I’m looking at suggests that Microsoft’s cloud business has been on fire over the past few months. Ultimately, that should lead to headline beating numbers which will keep the rally in MSFT stock alive.
Bigger picture, continued cloud strength will keep MSFT stock on a longer-term winning trajectory. Until that cloud strength cools, MSFT stock will keep making new highs.
Investors Brushed Off Earlier Disappointment
Broadly speaking, Microsoft’s upcoming third quarter earnings report is critical because it has the power to either confirm or negate the big year-to-date rally in MSFT stock.
To be sure, this isn’t the first time we’ve heard numbers from Microsoft in 2019. Back in late January, the company delivered Q2 numbers that were largely underwhelming. The big negative? Slowing growth. Revenue growth slowed from 18% in Q1 to 12% in Q2, while operating profit lost its mojo, with growth sliding from 28% to 18%. The culprit behind slower top- and bottom-line growth? Slowing cloud expansion, and that wasn’t a bullish sign, since the Microsoft growth narrative goes as its cloud businesses go.
But, investors largely brushed off those slowing growth concerns, and MSFT stock has rallied ever since. Why? Because investors chalked-up slowing Q2 cloud growth to broadly deteriorating global economic conditions. Those global conditions have meaningfully improved since late 2018, and as such, investors are thinking that maybe the Q2 cloud slowdown at Microsoft was just a blip on the radar. They reason that Q3 numbers should be much better.
From this perspective, Microsoft needs to report a solid Q3 in order to satisfy bulls and keep MSFT stock in rally mode.
Earnings Will Be Good
Fortunately, I think Microsoft will deliver solid third-quarter numbers.
Over the past several months, Exxon (NYSE:XOM) has tapped Microsoft as its cloud service provider in what is reportedly the largest cloud computing partnership in the oil industry. Volkswagen struck a similar large cloud deal. Meanwhile, Microsoft has teamed up with Adobe (NASDAQ:ADBE), VMWare (NYSE:VMW), and Slack in separate landmark partnerships, all of which have only broadened the utility and use cases of Microsoft’s enterprise cloud solutions. Microsoft has also been named as one of the finalist for the Pentagon’s huge JEDI contract, with the other being Amazon (NASDAQ:AMZN).
In other words, it appears that over the past several months, Microsoft’s cloud businesses have re-gained momentum that was lost in late 2018. This momentum will show up through improved Q3 growth rates, which will excite bulls and keep the stock in rally mode.
Longer term, this trend should continue to play out in favor of MSFT stock. The global cloud growth narrative is still in its first few innings, and Microsoft has established itself as an entrenched and dominant player in that industry. Thus, as cloud becomes a bigger and bigger piece of the total Microsoft pie, overall growth rates and margins will continue to improve. That will lead to healthy profit growth, which will ultimately keep MSFT stock on a winning trajectory.
Bottom Line on MSFT Stock
The big picture here is very easy to digest. Cloud is a huge growth industry, and Microsoft is right at the heart of all that growth. Thanks to the company’s dominant position in the secular growth cloud industry, MSFT stock has secured a bright future for itself.
As of this writing, Luke Lango was long ADBE and AMZN.
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