Big market downturns can be some of the best times to buy stocks -- but there are caveats. First, market downturns are often accompanied by economic weakness. That means some companies don't survive, or they come out weaker than before. However, strong companies can take advantage in downturns, emerging with even better growth prospects and market share on the other side.
The past year's rate-hiking cycle has been one of those market downturns, when even cloud and software leader Microsoft (MSFT -2.45%) has seen its stock decline 32% from all-time highs, despite its extraordinary combination of high-quality characteristics. That opens up a nice opportunity for investors to buy or add shares on this dip.
Microsoft's defensive capabilities
The reason investors can confidently buy Microsoft's stock, despite difficult economic headlines, is that it has some superior defensive qualities. First, its balance sheet is robust, with $107 billion in cash, against just $48 billion in debt. That cash position is the result of Microsoft's various wide-moat, cash-generative businesses.
How do we know Microsoft's various business segments have wide moats? Well, Microsoft makes a stunningly high 42% operating margin and earns a 43% return on equity. Those high numbers show that Microsoft operates competitively advantaged and/or entrenched businesses, owing to both strong network effects and high switching costs.
A strong network effect can be seen in Microsoft's Office Suite, which includes Word, PowerPoint, Excel, and other critical business software. Over the past 30 years, Office has become a standard upon which business gets done. Since everyone needs to learn the industry standard, everyone gets trained on Office, and with each new adopter, it only further cements Office's moat against would-be rivals. The same goes for LinkedIn, which has strong network effects of social media companies for jobs and job-seekers, and Windows, which is a standard operating system for the majority of the world's PCs.
In terms of high switching costs, both Microsoft's Dynamics enterprise resource planning software and Azure cloud infrastructure benefit from this advantage. Once a business utilizes a platform to house all of its data and to run its business, it's very hard to switch everything over to another vendor.
Need more evidence of how defensive Microsoft is? It's actually one of only two companies with a AAA rating from Standard & Poor's -- an even higher rating than that of the U.S. government, which saw its credit rating lowered to AA+ in 2012 when Republicans engaged in a debt ceiling standoff in Congress.
And how Microsoft can come out stronger on the other side
Because of its ample cash flows, Microsoft also has the means to play offense, no matter where we are in the economic cycle. That's a huge advantage, provided management knows how to allocate capital. And it certainly seems that's the case, given Microsoft's excellent record under CEO Satya Nadella, who took the job in 2014.
For instance, even though the company was late in realizing the potential of cloud computing, Microsoft had both the financial means and technical capability to build a strong cloud platform, which is now the second-largest in the world and growing at high rates.
Fast-forward to today, and we see Microsoft continuing to invest and acquire companies in pursuit of growth. For instance, while Microsoft's software and cloud businesses are each booming, Microsoft also has other businesses that, while good, sometimes take a back seat. These include both its Xbox gaming platform, the third-largest video game platform in the world, as well as its Bing search engine, a far distant second place in Search.
Yet what has Microsoft done over the past two years? In late 2021, Microsoft made an enormous $69 billion bid for game studio Activision Blizzard, when Activision was dealing with the fallout of multiple sexual harassment scandals. While the company has a fight with regulators ahead of it, the bid shows Microsoft is still aggressive and opportunistic in pursuing growth even outside of its core enterprise software platforms.
And it looks as though Microsoft still harbors ambitions for Bing. Microsoft invested $1 billion in OpenAI in 2019, the company behind the new ChatGPT chatbot that has taken the tech world by storm over the past two months. Last week, it was reported Microsoft is currently in talks to perhaps invest another $10 billion into OpenAI for a large stake. According to reports, ChatGPT could infuse Bing and its other products with cutting-edge AI capabilities, perhaps even building a better rival to the dominant Google Search.
Microsoft: Buy on the dips
Because Microsoft has such highly defensive qualities, investors can feel safe buying shares in a downturn. And because Microsoft has the ability to invest in growth and make acquisitions, which it has done very impressively since 2014, investors shouldn't discount the company's growth prospects. That makes it a growth stock investors can buy and hold through any market downturn.
