Many factors have gone into Costco's (COST 1.01%) success as a business and as a stock investment. The warehouse giant has been picking up market share for decades, for one, mainly thanks to its popular price leadership selling approach.
Yet, the real engine behind its positive financial returns is Costco's incredibly predictable profit growth. Rather than generating most of its earnings through product markups like other retailers do, Costco's profits flow from its steadily rising membership fees. As a result, annual earnings don't swing wildly with shifting sales trends.
Investors can get exposure to this kind of predictable income in other, more profitable industries. In fact, there's a huge tech company doing something similar with its software-as-a-service selling approach. Let's look at why you might want to add Microsoft (MSFT 1.82%) stock to your portfolio today.
Subscriptions and services
Microsoft has a vast empire of products spanning video games, productivity software, computing devices, and cloud enterprise services. But these sales are increasingly shifting toward recurring revenue in the form of annual subscriptions or contracts.
For example, the software titan counts nearly 80 million subscribers to its 365 consumer platform. And most of its profits come from cloud services contracts with large enterprises that have committed to its cloud-based platforms, such as Azure.
You can see the positive impact of this recurring revenue in Microsoft's steady sales figures. Despite declines in big areas like video gaming and PC hardware last year, overall revenue rose 11% after accounting for currency exchange rate swings. That expansion rate accelerated in early 2024, landing at 16% in the most recent quarter.
Higher profits
Unlike Costco, Microsoft stands out as one of the most profitable businesses in its industry. The retailer's margin hovers near 3% of sales, while Microsoft's operating profit is 44% of sales, easily surpassing peers like Amazon and Apple.
MSFT Operating Margin (TTM) data by YCharts. TTM = trailing 12 months.
Microsoft's financial strength is also clear from its surging cash flow, which provides resources that management can direct toward acquisitions and growth investments like artificial intelligence (AI). The tech giant is sitting on $81 billion of cash as of early 2024. It generated $19 billion in just the past quarter compared to Costco's $5 billion. This gap reflects a level of efficiency that's only possible through Microsoft's massive global sales base in the highly profitable software industry.
The price is right
Of course, you'll have to pay a premium for exposure to these positive factors. Microsoft stock is valued at 14 times sales compared to Apple's price-to-sales ratio of 8. That valuation has climbed steadily over the past year, too, as optimism surged over the impact of AI on software demand.
That means the main risk with buying Microsoft stock is paying too high of a price for this high-performing business. Returns from here could disappoint shareholders if the AI boom doesn't materialize, for example, or if tech IT spending trends slow back down. Microsoft might fumble a pricey acquisition in its aggressive efforts to lead the AI shift as well.
If you're comfortable with these risks, though, Microsoft can potentially deliver lots of value in an investor's portfolio over the next several years. Looking back, you might not remember paying a bit of a premium for the business, but you'll be happy you did.
