Microsoft (MSFT +2.20%) is currently the only company worth over $3 trillion. That makes it the most heavily weighted stock in both the S&P 500 and the Nasdaq Composite, but not the Dow Jones Industrial Average.
However, a 6.4% decline in UnitedHealth Group (UNH +0.75%) stock on April 2 has pushed Microsoft just 8% away from becoming the most valuable stock in the Dow Jones. Here's why UnitedHealth sold off and why Microsoft has a long runway for earnings growth, as well as a path to eventually surpassing UnitedHealth.
Image source: Getty Images.
Bad news for health insurance companies
It's uncommon to see a stodgy dividend-paying insurance provider fall big for a non-earnings-related reason. But that's exactly what happened to health insurance companies on April 2 when the federal agency that administers the Medicare program approved a lower-than-expected rate increase. Some health insurance companies were expecting a larger increase to keep up with rising medical costs.
Even after the sell-off, UnitedHealth is still up 87% over the last five years -- outperforming the S&P 500. The outperformance is one reason why UnitedHealth has grown to become the most important stock in the Dow Jones Industrial Average -- which weights components based on their rather arbitrary stock price rather than market cap.
However, Goldman Sachs (GS +0.06%) is up an even better 106% over the last five years, and Microsoft is up a staggering 250%. They are the two closest components to overtaking UnitedHealth for pole position in the Dow.
Microsoft is more expensive for good reason
The easiest way for a stock to go up is to grow earnings or chart a path toward accelerated earnings growth. Microsoft has done the trifecta of undergoing a valuation expansion with a higher multiple, boosting earnings toward record highs, and accelerating its top- and bottom-line growth rate, largely thanks to artificial intelligence (AI) monetization and the growing need for cloud infrastructure.
In the chart, you can see that Microsoft stock now trades significantly above its medium-term and long-term median.
MSFT PE Ratio data by YCharts.
Just because a company has a higher valuation today than in the past doesn't necessarily mean it is overvalued. Sometimes, the investment thesis changes, and a stock deserves a higher multiple. Despite being a legacy tech company, Microsoft's investment thesis has changed in a relatively short period of time.
Entering a new growth gear
The company has gone from a moderate-margin, moderate-growth company to a high-margin, faster-growth company. Ten years ago, Microsoft's trailing-12-month (TTM) revenue was less than $100 billion, and its margins were in the low 30% range. Now, it is earning TTM revenue above $225 billion, and its operating margin is at a 10-year high of 44.2%.
MSFT Operating Margin (TTM) data by YCharts.
Contributing factors include the rise of high-margin themes like cloud infrastructure, where Microsoft Azure is the No. 2 player in market share, behind only Amazon Web Services (AWS).
Microsoft is leveraging AI across its business units, mainly through AI virtual assistants called Copilots. There are Copilots for Microsoft 365, GitHub Copilots, Azure AI for its Intelligent Cloud segment, AI for LinkedIn, Copilot for Security, and so much more. AI is making Microsoft's existing products and services better, which is driving margins and overall growth.
Microsoft also has a rock-solid balance sheet and is reducing its outstanding share count through buybacks, more than offsetting its expensive stock-based compensation program. Microsoft pays more dividends than any other U.S.-based company, which is another way it rewards its shareholders.
All told, Microsoft can justify the recent run-up in its stock price, which bodes well for further growth and for the company to eventually become the most important component of the Dow.
Microsoft is moving markets
At the end of the day, being the most important component in all three major indices would mean little more than bragging rights for Microsoft. But it is useful to know what makes up an index and how sector weights and component weights can move the market.
For example, five stocks have contributed the vast majority of the S&P 500's 2024 gains. A high weighted component that goes on a run, like Nvidia, can move the whole market. And if you don't own it, it would be easy to underperform the benchmarks.
At the time of this writing, Microsoft makes up 8.8% of the Nasdaq Composite, 7.2% of the S&P 500, and 7.1% of the Dow Jones Industrial Average. This means a 15% move in Microsoft stock would move all three indices by over 1 percentage point.
Microsoft matters whether you are comparing your performance to that of one of the major indices, or you are buying an index fund or exchange-traded fund (ETF). Regardless of whether Microsoft becomes the most important stock in the Dow or not, it's a company worth paying attention to, even if you have no interest in owning it.
