Should You Buy Microsoft (MSFT) Stock?

John Divine, Mark Reeth
·9 min read

Twenty years ago, Microsoft Corp. (ticker: MSFT) was the most valuable company in the world.

Today, Microsoft is worth around $1.8 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 the groundbreaking tech titan it once was, but Microsoft is far from obsolete and continues to remain relevant in markets around the world.

Is Microsoft stock still a "buy" in 2021? To help you determine if you should add Microsoft to your portfolio, let's take a look at the biggest pros and cons associated with MSFT:

-- Microsoft stock at a glance.

-- Pros of buying.

-- Cons of buying.

-- Bottom line: Should you buy Microsoft?

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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 that it has utilized ever since.

By the 1990s, computers became small enough and economical enough for the average American household to afford. The end market wasn't just corporations and academia anymore, propelling Microsoft to new heights.

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.

Fast forward to today, and Windows is still a major cash cow for Microsoft. But the company hasn't just sat back and reaped its rewards -- during the tenure of its current CEO, Microsoft has diversified into new and exciting avenues of growth, like cloud computing, 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.

Microsoft clearly learned a hard lesson from missing out on the opportunities presented by new technology, and the company doesn't intend to repeat its past mistakes when it comes to cloud computing.

Microsoft has approached the cloud 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 ( AMZN) and its Amazon Web Services. In the second quarter of fiscal 2021, Microsoft Azure revenue grew by 50% year over year, fueling the 26% increase in server products and cloud services revenue.

Azure and Microsoft's cloud services reside in Microsoft's Intelligent Cloud segment, and the success of both products was enough to propel the division to 21% revenue growth year over year. 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.

While the new and growing cloud business is driving profits at Microsoft, another of the company's biggest "pros" is essentially the same as it was 20 years ago: Microsoft has an unbelievable "moat," or 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 more than 76% 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 second quarter of its fiscal 2021 year, Windows commercial products and cloud services revenue grew 10%.

Windows is part of a business segment Microsoft labels "More Personal Computing," a segment that also accounts for the Xbox and associated services, sales of the Surface tablet and advertising revenue from Bing.

Search advertising revenue from Bing, a perennial loser lagging behind Google's search engine, increased a modest 2% last quarter -- though that's well up from the 10% loss the division had in the first quarter of fiscal 2021. Meanwhile, thanks to higher demand for its Surface tablet due to remote work and education, Surface revenue increased 3% -- but that's far below the 37% revenue increase from the first quarter.

While the rest of the More Personal Computing segment was a mixed bag this quarter, the one standout was the Xbox. The successful release of the Xbox Series X and Series S consoles in November propelled Xbox hardware revenue up 86%. In addition, Xbox content and services revenue rose 40%, contributing to a 51% increase in overall gaming revenue.

Combined with Windows, these diverse businesses propelled revenue in the More Personal Computing segment up 14% year over year.

Microsoft's final segment, Productivity and Business Processes -- the segment containing Microsoft Office and LinkedIn -- was no slouch last quarter either. Dynamics 365 revenue rose 39%, while LinkedIn revenue was up 23%. When combined with impressive growth in Office Consumer and Commercial products, the Productivity and Business Processes segment saw a 13% increase in revenue.

Intelligent Cloud, More Personal Computing, and Productivity and Business Processes all enjoyed strong growth in the second quarter of fiscal 2021 and combined to push Microsoft's revenue up 17% year over year. Diluted earnings per share (EPS) last quarter grew at an even more impressive rate, jumping 34% from the same period a year before.

Both revenue of $43.08 billion and EPS of $2.03 beat analyst expectations of $40.18 billion and $1.64, 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 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.

[Read: Should You Buy Netflix (NFLX) Stock?]

Cons of Buying Microsoft Stock

The "cons" to buying Microsoft stock? Those are a bit harder to find.

The most glaring risk might seem trite, but in simple terms, it's that MSFT stock may be too high right now. Like many of its tech peers, Microsoft had an impressive 2020: shares rose nearly 40% over the course of the year, which is why the traditional metrics like the price-earnings ratio (PE) and price-earnings to growth ratio (PEG) make MSFT stock look 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 37.5. 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 $1.8 trillion to $3.6 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, and while Azure is steadily gaining ground, 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 consoles are going head-to-head against Sony's ( SNE) PlayStation 5.

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, ready to change the game.

[Read: Best Tech Stocks to Buy This Month.]

The Bottom Line: Should You Buy 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 extremely impressive. 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 for a long time to come; on top of that, at the time of this writing, it pays a modest 1% dividend. That's a nice cherry on top of an excellent long-term investment.

When you look at the risk versus reward, Microsoft is a phenomenal stock to own.