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Pros and Cons to Buying Microsoft (MSFT) Stock

John Divine

Two decades into the millennium, Wall Street has adopted a peculiar jargon, referencing billion-dollar-plus tech startups as "unicorns." Forget about the fact that these companies don't have to be profitable, nor do they need to be particularly rare to earn this moniker.

Microsoft Corp. (ticker: MSFT), however, is a real unicorn. Alongside longtime rival Apple ( AAPL), Microsoft is one of just two companies worth over $1 trillion. Perhaps more impressive, the software giant has been a major player in tech since the early 1980s.

Twenty years ago, Microsoft was the most valuable company in the world. Today, despite the ever-changing world of technology and all sorts of venerable new competitors, MSFT is still either the first- or second-most valuable company in the world on any given day.

Is Microsoft stock still a buy going into 2020? Here's a look at the biggest pros and cons associated with shares.

[See: 10 Major Upcoming IPOs to Watch in 2019.]

Microsoft Stock at a Glance

Rising to prominence in the late 1970s and early 1980s with its BASIC programming language, Microsoft's software became the industry standard for early personal computers made by the likes of IBM ( IBM) and Apple. This gave MSFT a crucial first-mover advantage that the company was keen never to cede.

While Microsoft's ambitious offerings soon spanned not merely languages but also operating systems and applications, it became manufacturers' go-to solution for shipping a product that consumers would be able to utilize productively.

By the 1990s, Moore's Law had helped make computers small enough and economical enough for the average American household or typical elementary school to afford -- the end market wasn't just corporations and academia anymore.

Combine this rapidly growing pie with the convenient timing of the internet's debut, and soon PCs, something which the everyday consumer wasn't even thinking about in the early '80s, became totally commonplace. Commonplace, too, was the operating system (OS) they ran on: Windows, the pre-installed, Microsoft-made software that the vast majority of these new computers ran on. Users loved the Windows user experience and practical capabilities, especially the Microsoft Office suite of apps that Microsoft cashed in on, highlighted by Microsoft Office and the likes of 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 a few decades and Windows is still a major cash cow for MSFT stock, 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 and social networking. In 2016, Microsoft bought LinkedIn for $26 billion, and that investment continues to pay off in a strong labor market.

What started as a pure play, a company entirely reliant on the Windows OS, Microsoft is now far more diversified, with a dominant grip on the video gaming market (Xbox), a growing hardware division highlighted by its Surface tablets, its overlooked Bing search engine, and of course its newfound growth lever known as the cloud.

Pros to 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 Satya Nadella (2014-present). Gates' tenure was characterized by an almost perfectly timed 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.

Though it would eventually improve most of these shortcomings, MSFT stock performed far worse than the S&P 500 index over the Ballmer era.

Since 2014 however, MSFT 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, Microsoft stock's biggest "pro" is essentially the same as what it was 20 years ago: the company has an unbelievable "moat" -- a high barrier to entry. Hundreds of millions of computer 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; the desktop market share for Windows is 77% globally.

Thankfully for MSFT shareholders, the Windows 10 upgrade cycle is currently driving revenue growth at the company; support for the older OS, Windows 7, will phase out by January 2020. This essentially forces corporate clients -- and any consumers who want customer support every now and then -- to switch to the new Windows 10.

The second major "pro" to buying Microsoft stock is its growing reliance 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, now you'll pay Microsoft $100 a year to use Office across all your devices.

There's almost nothing Wall Street loves more than recurring revenue, so this was an ingenious move.

[READ 7 Top Web-Scale Spending Stocks to Buy]

The second, and arguably even more exciting way, MSFT 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 AWS offering. Microsoft doesn't break out exact revenue figures, but to get an idea of just how quickly this space is growing, Azure revenue grew by 59% last quarter. That means it's increasing its market share compared to AWS, which grew by 35% in the same quarter.

Just recently, the company won out a coveted $10 billion cloud contract with the Pentagon, beating out Amazon.

Lastly, and this is quite an important issue to consider for any stock, but the risk you take on by investing in Microsoft is by all indications 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 ( FB), Alphabet ( GOOG, GOOGL), Amazon and Apple, but Microsoft is one of just two U.S. companies that all major credit rating agencies actually consider a lower default risk than the federal government of the United States of America.

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 to Buying Microsoft Stock

The reasons to consider buying the top software company in the world are litany. The "cons" to buying Microsoft stock? 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. By traditional metrics like the price-earnings ratio (28) and PEG ratio (1.9), Microsoft is trading at richer valuations than the S&P 500.

There's nothing wrong with that on its face; most growth stocks do 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 28 P/E ratio. Back in the '80s and '90s it wasn't unusual for earnings to double every two years or so, it's much easier to go from numbers like $100 million to $200 million than $1 trillion to $2 trillion. There's only so much money, and so much growth, in the world.

Another potential risk to keep abreast of: If a competitor develops a breakthrough in something like quantum computing, artificial intelligence, the smart home, or entertainment where MSFT 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 older, less technologically sophisticated Ballmer was.

The real risk is that that P/E ratio of 28 comes down to something even moderately lower; should the market revalue MSFT at Apple's P/E ratio (21), a cool $270 billion would be shaved off Microsoft's market cap overnight.

[See: 10 of the Best Dividend Stocks to Buy for 2019.]

The Bottom Line on Microsoft Stock

The fact that the biggest blatant and visible risks associated with Microsoft stock are mostly just the usual risks associated with buying any stock 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 is remarkable. The fact that its financial security is considered safer than U.S. bonds (traditionally considered "risk-free" assets in financial textbooks) is almost without parallel.

Plus, Microsoft has a great moat in an industry that will almost certainly still be around a decade from now; on top of that it pays a modest 1.5% dividend, roughly in line with the yield on 10-year Treasurys. So if you can sit on your hands for 10 years, forget Treasurys, you might as well buy some MSFT -- you'll get the dividend, and likely some sizeable capital gains -- unless something goes horribly wrong or Nadella decides to channel his inner Ballmer.

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

Take note, Silicon Valley: This is a true unicorn.

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