I suspect if you asked Warren Buffett about Microsoft (MSFT -1.84%), he'd probably acknowledge that he admires the company's business. After all, Microsoft reigns as one of the biggest giants in technology. It's a cash cow with a rock-solid financial position.
Over the last five years, Microsoft has delivered a return nearly four times greater than Berkshire Hathaway (BRK.A 0.64%) (BRK.B 0.54%). That outperformance could continue for years to come, considering that Microsoft ranks as a leader in nearly every fast-growing tech area, including artificial intelligence (AI), cloud computing, and virtual reality (VR). So why isn't Buffett buying Microsoft stock hand over fist?
Three strikes
Buffett once stated that he didn't initially invest in Microsoft because of "stupidity." He didn't accurately gauge the company's potential. But we can strike this reason from the list of why the legendary investor isn't buying Microsoft stock now. He's certainly no longer ignorant about Microsoft's potential.
Another reason that Buffett has previously given for not investing in Microsoft was his friendship with Bill Gates. His concern was that he and Gates could be accused of exchanging insider information because of their close relationship. Buffett said in 2018 that "it just would be a mistake for Berkshire to buy Microsoft" because of this possibility.
However, Gates hasn't been Microsoft's CEO since 2008. He stepped down from the tech giant's board of directors in 2020. Buffett's friendship with his fellow multibillionaire shouldn't be a factor in any decisions about Berkshire investing in Microsoft today. Strike two.
What about the idea that tech stocks are out of Buffett's wheelhouse? That might have held up in the past but not now. Berkshire Hathaway investment managers Todd Combs and Ted Weschler have initiated positions in several tech companies in recent years with Buffett's blessing. Apple even ranks as Berkshire's biggest holding by far and is one of Buffett's favorite stocks. Strike three.
Buffett's key test
I do think we can determine why Buffett isn't scooping up shares of Microsoft stock today, though. We only need to look back at what he wrote to Berkshire Hathaway shareholders nearly 10 years ago.
In 2014, Buffett recommended that investors focus on the future earnings of a business. He added, "If you don't feel comfortable making a rough estimate of the asset's future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility."
Buffett echoed this thought in his explanation of the process that he and his longtime business partner Charlie Munger use to evaluate stocks. He wrote:
We first have to decide whether we can sensibly estimate an earnings range for five years out, or more. If the answer is yes, we will buy the stock (or business) if it sells at a reasonable price in relation to the bottom boundary of our estimate. If, however, we lack the ability to estimate future earnings – which is usually the case – we simply move on to other prospects.
The main reason why Buffett isn't buying Microsoft stock is probably that he and his team don't have a warm-and-fuzzy feeling about its valuation with respect to future earnings. That doesn't necessarily mean that Buffett is bearish about Microsoft. My guess is that he isn't. However, technology is advancing rapidly. That makes it harder to estimate earnings several years out with a high level of confidence.
This view aligns with Buffett's mindset in 1997, by the way. He wrote in an email to an acquaintance who worked with Microsoft at the time that he didn't feel "capable of assessing probabilities" about Microsoft's earnings. He acknowledged that if he were "forced to make a guess," he'd bet on Microsoft instead of against it. However, Buffett used a baseball analogy, stating, "I prefer to structure investing as a no-called-strikes game and just wait for the fat one [the ideal pitch]."
Should you buy Microsoft stock hand over fist?
My Motley Fool colleague Anthony Di Pizio believes that Microsoft could become the world's first $5 trillion company by 2030. Considering Microsoft's growth opportunities in AI and cloud services, I wouldn't be surprised if this prediction comes true.
But that promising possibility doesn't necessarily mean that you should buy Microsoft stock hand over fist. Buffett obviously thinks that there are better stocks than Microsoft to invest in; otherwise, he'd be loading up on the tech stock. I own shares of Microsoft and fully expect solid returns going forward. However, I agree with Buffett's apparent view that there are even better stocks to buy right now.
