What Happened

Microsoft reported earnings on Jan. 29 and exceeded earnings and revenue expectations. Its focus on its cloud business seems to be paying off, with revenue from its"Intelligent Cloud" segment topping expectations and increasing as a share of its overall revenue from 29% to 32%.

(Below is Investopedia's original earnings preview, published Jan. 23, 2020)

What to Look for

Microsoft Corp. (MSFT) shares have risen twice as fast as the S&P 500 in the past year, pushing its market value to nearly $1.3 trillion and making it the second most valuable company in the world after Apple Inc. (AAPL). Much of Microsoft’s recent success has been driven by its cloud-computing business, and investors will be focusing intently on that sector when Microsoft reports earnings for Q2 of FY2020 after close on January 29. Analysts currently are forecasting a 21.7% rise in cloud revenue, boosting corporate profits and sales for the quarter compared to a year earlier.

One Year Total Return for S&P 500 and Microsoft
Source: TradingView.

Since posting an anemic 2.3% year-over-year (YOY) rise in corporate revenue in Q2 of FY2017, Microsoft's revenue gains have accelerated. It has reported YOY corporate revenue growth of about 12% in Q2 FY2018 and again in Q2 FY2019. Diluted earnings per share (EPS) has seen more substantial changes over the same time period. In Q2 in FY2018, the company posted an atypical loss of $0.82 per share. Since then, EPS rebounded in Q2 FY2019 and surpassed Q2 FY2017 levels, the last second quarter which saw positive EPS.

Analysts expect Microsoft to post quarterly revenue gains at a solid, but slower pace of around 9.9% YOY in Q2 FY2020. That would be the slowest growth rate in 9 quarters. Still, analysts expect Q2 FY2020 quarterly EPS to climb by nearly 22% YOY.

Microsoft Key Metrics
  Estimate for Q2 FY2020 Q2 FY2019 Q2 FY2018
Earnings Per Share $1.32 $1.08 -$0.82
Revenue (in billions) $35.7 $32.5 $28.9
Cloud Revenue (in billions) $11.4 $9.4 $7.8

Source: Visible Alpha

In recent quarters, investors have watched Microsoft's success in attracting new cloud-computing customers, which has helped accelerate its earnings, revenue and stock growth. In particular, Azure, the company's cloud-computing service, is up against its dominant rival, Amazon Web Services, in the battle to raise its market share. Microsoft has moved to aggressively grow its intelligent cloud segment in an effort to shift its focus away from selling software and other products tied to PC sales, which have struggled as the market has dwindled in recent years. For these reasons, cloud revenue is a key indicator of Microsoft's performance.

The company has managed to grow its fiscal Q2 cloud revenue YOY for several years. With consensus estimates predicting $11.4 billion in quarterly revenues for this segment in FY2020, cloud revenue is approaching double what it was just three years earlier. Including estimates for Q2 FY2020, Microsoft's cloud revenue has risen by more than 20% in 6 of the past 7 quarters going back to Q4 FY2018.

Perhaps more important, Microsoft's cloud revenue is growing relative to its total revenue as well. The intelligent cloud segment accounted for 27.0% of total revenue for Q2 FY2018, 28.9% of total revenue for Q2 FY2019, and is expected to be 32.0% of total revenue in Q2 FY2020. While Microsoft continues to offer a host of other products and services, its cloud business is clearly the main driver of growth.