Microsoft is now worth around $1.6 trillion, and other tech titans like Alphabet ( GOOG, GOOGL) and Facebook ( FB) are not too far behind. The company that brought you Windows may not be alone at the top anymore, but Microsoft is far from obsolete and continues to remain relevant in markets around the world.
But is Microsoft stock still a “buy” in late 2020? Here’s a look at the biggest pros and cons associated with MSFT.
Microsoft Stock at a Glance
Rising to prominence in the late 1970s and early 1980s, Microsoft’s software became the industry standard for early PCs made by the likes of IBM ( IBM) and Apple ( AAPL). This gave Microsoft a crucial first-mover advantage.
By the 1990s, computers became small enough and economical enough for the average American household or typical elementary school to afford one. The end market wasn’t just corporations and academia anymore, propelling Microsoft further.
As home computers became commonplace, so too was the operating system they used: Windows, the preinstalled, Microsoft-made software. Consumers loved the Windows user experience and its practical capabilities, especially the Microsoft Office suite of applications such as Word, Excel and PowerPoint.
By earning a hefty licensing fee on each computer sold with Windows and Office, Microsoft was able to achieve previously unimaginable scale over a short period.
A few decades later and Windows is still a major cash cow for Microsoft. But the company has also been able to diversify, and its most exciting future growth prospects are expected to come from other areas like cloud computing, social networking, remote work apps and video games.
Pros of Buying Microsoft Stock
There have been three CEOs since Microsoft was founded in 1975: co-founder Bill Gates (1975-2000), Steve Ballmer (2000-2014) and the current chief executive Satya Nadella. Gates’ tenure was characterized by a company that experienced virtually unprecedented growth, making him the richest person in the world by the 1990s. Ballmer’s tenure was a struggle, as Microsoft failed to stay at the forefront of tech, largely missing the boat on huge growth industries it was perfectly positioned to dominate like smartphones, search engines and social networks.
Since 2014, Microsoft has been led by Nadella, a period that thus far has been characterized by a return to Wall Street prominence, outperformance, revenue diversification and its biggest theme: cloud computing.
Today, one of Microsoft’s biggest “pros” is essentially the same as what it was 20 years ago: The company has an unbelievable “moat,” a high barrier to entry. Many users around the world have learned everything they know about computers using Microsoft’s Windows operating system.
If you don’t have an Apple computer, Windows is by far the operating system of choice for manufacturers and consumers alike, holding the majority of the desktop market share worldwide.
But Microsoft doesn’t have to release new versions of Windows constantly to keep cashing in on its operating system. In the first quarter of its fiscal 2021 year, Windows consumer products and cloud services revenue grew 13%.
Windows is part of a business segment Microsoft labels “More Personal Computing,” and the segment also accounts for the Xbox and associated services, sales of the Surface tablet and advertising revenue from Bing.
Besides Bing, a perennial loser lagging behind Google’s search engine, More Personal Computing enjoyed some modest highlights last quarter. MSFT also saw increased demand for its Surface tablet for remote work and education, resulting in a 37% increase in Surface revenue — an acceleration from the already impressive 28% growth rate seen in the prior quarter.
Combined with Windows, these diverse businesses propelled revenue in the More Personal Computing segment up 6% year over year. But the big growth driver at Microsoft right now is the cloud.
The second major “pro” to buying Microsoft stock is its growing focus on the cloud. The company does this in two ways: First, it offers its suite of productivity applications, Microsoft Office, as a cloud-based ” software as a service” offering. Instead of earning a one-time cut when someone buys a Windows- and Office-equipped computer, consumers now pay Microsoft $99.99 a year to use Office across all devices.
The second way Microsoft is cashing in on the cloud is with its cloud computing offering Azure. It’s the second-largest player in the rapidly growing field, trailing only Amazon.com ( AMZN) and its Amazon Web Services. In the fiscal 2021 first quarter, Microsoft Azure revenue grew by 48% year over year, fueling the 22% increase in server products and cloud services revenue year over year.
But the strength of Azure and Microsoft’s cloud services was enough to propel the Intelligent Cloud segment to 20% revenue growth year over year, and that growth will likely only continue thanks to key contracts like Microsoft’s recent $10 billion deal with the U.S. Department of Defense, as well as more commercial wins with private companies. SpaceX’s Starlink project, for instance, which aims to bring satellite internet to all areas of the world, from remote outbacks to populous city centers, is using Azure as its cloud partner.
The cloud, personal computing and Microsoft’s final segment, Productivity and Business Processes — the segment containing Microsoft Office and LinkedIn — all enjoyed strong revenue growth in the first quarter of fiscal 2021 and combined to push Microsoft’s revenue up 12% year over year. Diluted earnings per share (EPS) last quarter grew at an even more impressive rate, jumping 32% from the same period a year before.
Both revenue of $37.2 billion and EPS of $1.82 beat analyst expectations of $35.72 billion and $1.54, respectively.
MSFT shareholders who have spent 2020 watching their portfolios take a roller coaster ride must be relieved that their investments include a company as stable as Microsoft. This brings up the final pro for investing in the house that Gates built: stability.
The risk you take on by investing in Microsoft is fairly low for long-term investors. Not only is Microsoft notably absent from the U.S. government’s looming antitrust investigations into Big Tech peers Facebook, Alphabet and Amazon, but Microsoft is one of just two U.S. companies that all major credit rating agencies actually consider to be a lower default risk than the federal government.
That’s right: Microsoft, along with Johnson & Johnson ( JNJ), is more likely to pay back your loan than Uncle Sam. It’s hard to be much more financially secure than that.
Cons of Buying Microsoft Stock
The “cons” to buying Microsoft stock? Those are a bit harder to find. Of course, Wall Street was quick to pick apart Microsoft’s late October earnings report to find negatives, and the stock fell roughly 4% as analysts bemoaned softer-than-expected revenue growth guidance.
The most glaring risk might seem trite, but in simple terms, it’s that MSFT stock may be too high right now. By traditional metrics like the price-earnings ratio (PE) and price-earnings to growth ratio (PEG), MSFT stock looks a little rich.
There’s nothing wrong with that on its face. Most growth stocks trade for higher multiples than the market at large, for the rational reason that earnings are expected to grow more quickly than the wider market.
The question, however, is whether a trillion-dollar company like Microsoft can still be expected to grow at a quick enough rate to justify its PE of 33. Back in the ’80s and ’90s, it wasn’t unusual for earnings to double every two years or so, and it’s much easier to go from numbers like $100 million to $200 million than $1 trillion to $2 trillion.
When it comes to FAANG stocks, there’s another potential risk to keep abreast of: If a competitor develops a breakthrough in something like quantum computing, artificial intelligence, smart home devices or entertainment, where Microsoft should’ve been competing more aggressively, that’s a missed opportunity. But Nadella is far less likely to miss those massive paradigm shifts than the less technologically sophisticated Ballmer.
That said, Microsoft faces stiff competition in nearly every industry in which it dabbles. Surface sales may increase, but it’s doubtful they’ll eclipse the iPad anytime soon. Google is unlikely to lose out to Bing in the near future, either (Microsoft’s search revenue continued to decline last quarter). Azure is steadily gaining ground, but Amazon still remains the market leader. There are always new competitors ready to take on Microsoft’s dominance — with Slack ( WORK) and Zoom Video Communications ( ZOOM) challenging Microsoft Teams, while the new Xbox Series X will face off against Sony’s ( SNE) new PlayStation 5 this holiday season.
The key to Microsoft’s ongoing success remains Windows and the Office suite of products. That was true in the 1990s, and it’s still true in the 2020s. As long as Microsoft remains dominant in those markets, it will be a viable company with a bright future ahead — but investors should always be wary of new competitors lurking just over the horizon.
The Bottom Line on Microsoft Stock
The fact that the biggest risk associated with Microsoft stock is simply the normal volatility that comes with investing in equities is a remarkable statement.
For a company of its size to not have extreme legal or antitrust woes or hardcore competition threatening its bread-and-butter cash cow is remarkable. The fact that its financial security is considered safer than U.S. bonds is almost without parallel.
Microsoft has a great moat in an industry that will almost certainly still be around a decade from now; on top of that, at the time of this writing, it pays a modest 1.05% dividend. That’s slightly more than the 10-year Treasury, which offers around 0.8% right now. So if you can “sit on your hands” with 10-year Treasurys, you might as well buy Microsoft stock and hold that for a decade instead — you’ll get the dividend, and likely some sizable capital gains — unless something goes horribly wrong, or Nadella decides to channel his inner Ballmer.
When you look at the risk versus reward, Microsoft is a phenomenal stock to own.
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Update 10/28/20: This story was published at an earlier date and has been updated with new information.