It’s been the year of the so-called FAANG stocks. Many commentators have pointed out that the FAANG members in fact account for the majority of the S&P 500’s gains year-to-date. Throw in Tesla (NASDAQ:TSLA) as well, and you have a popular high-voltage momentum stock portfolio. But this line of thinking overlooks one giant: Microsoft (NASDAQ:MSFT). MSFT stock briefly topped Apple (NASDAQ:AAPL) for the world’s largest company months ago.
And given Microsoft’s superior growth rate, there’s a good chance that Microsoft will again surpass Apple in coming years. While Apple has its excitement around the stock split and the fitness products, it can’t hide the fact that the business has barely grown its income over the past five years.
Microsoft, by contrast, still has a ton of upside thanks to its cloud business. Yet MSFT stock sells for 28x forward earnings, a significant discount to Apple’s 31x. And there’s more.
Ignore TikTok, The Excitement Is Elsewhere
The recent drama around MSFT stock mostly involves short-video app TikTok. With the Trump Administration urging a sale, it appeared that a major U.S. tech company would buy the asset from its Chinese owners. Microsoft and Oracle (NASDAQ:ORCL) were reportedly on the shortlist to buy TikTok.
However, as of this writing, it appears TikTok may not end up selling, and the odds are quite low in any case that Microsoft will be the eventual winner. Microsoft has dropped 10% over the past two weeks in part because it seemingly lost out on the chance to own this fast-growing asset.
But there’s no cause for alarm. Microsoft’s existing businesses are firing on almost cylinders. Last quarter, the core Windows ecosystem grew 7% — a chunky figure given its enormous installed base already. Meanwhile Surface surged 30% and Xbox rode the gaming wave to 68% upside. The Azure cloud business also posted 50% growth. Only search declined due to a drop in ad revenues. Still, Microsoft is getting a massive boost from current conditions, even if the stock price has trailed some peers this summer.
In addition to the company’s overall strength, it also has an upcoming catalyst. This separates it from many of the work-from-home stocks that will see their shares slide as attention turns elsewhere. Microsoft, by contrast, is launching its new video game consoles in November. It’s been many years since the last cycle. Thus, while gaming is generally not a huge piece of Microsoft’s overall revenue pie, 2021 could be a big year with both console sales and a flood of game sales for the new system.
Dividend Holds Appeal
Most investors don’t think of Microsoft as a dividend play. And understandably so. Microsoft’s shares yielded 2.5% at one point not too long ago when the stock price was much lower, however, as of last week, it was paying just 1.0%. So why care about the dividend?
You should think of Microsoft as an income stream because the dividend grows so quickly. In fact, Microsoft has increased its dividend more than 10%/year compounded annually for the past ten years. If you bought MSFT stock just five years ago, you’re now getting 5.1% annual yield on your 2015 purchase.
And the streak continues. On Tuesday, Microsoft announced another 10% dividend hike, as it will bump the quarterly dividend up from 51 cents to 56 cents per quarter. With the company earning more than $6 per share a year, this amounts to a payout ratio of just 30% or so, meaning that it can keep up this rapid dividend growth for many years to come. While Microsoft’s starting dividend isn’t huge now, at the rate grows, it can chip in a significant portion of your future income needs if you’re a long-term investor.
MSFT Stock Verdict
In a world of very expensive tech stocks, Microsoft holds more appeal than you might think. Consider the view from a relative basis. MSFT stock traded for as much as $190 prior to the pandemic. And it reached $210 for the first time for the July. Despite a sizzling tech rally late this summer, Microsoft hasn’t advanced any, on net, and it’s only up 10% or so through the duration of Covid-19.
Yet, when you think about companies that actually gained a tailwind from this year’s events, Microsoft is pretty high up the list. The core Microsoft software business is stronger than ever. The Azure cloud platform has gotten a big boost from the accelerated move to remote work. And other ancillary Microsoft services such as Skype and Github benefit from the work-from-home trend as well.
While I expect tech stocks in general to give back some of their dramatic 2020 gains as the pandemic starts to recede, Microsoft will fare better than most of its peers.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
Gallery: 5 Cloud Stocks Still Reaching for the Sky, Despite the Pullback (InvestorPlace)