Costco has undoubtedly established itself as a retail powerhouse, magnetizing investors with decades of consistent market share gains and a distinct price leadership strategy. Its success, however, predominantly stems from the stability of its profit growth, which is uniquely driven by soaring membership fees instead of volatile product sales.
However, a lesser-trumpeted investment rival enters the arena, flaunting similar predictability in income generation, but within the tech industry. Microsoft, with its software-as-a-service (SaaS) business model, embodies just that. Let’s explore why Microsoft, not Costco, deserves a prime slot in your stock portfolio.
The Subscription and Service Revolution
Microsoft’s revenue streams are pivoting towards recurrent income, like annual subscriptions and long-term contracts. The tech behemoth has amassed nearly 80 million users for its 365 consumer platform, and the bulk of its profits are rooted in extensive cloud services contracts with corporate titans committed to its cloud-based platforms, such as Azure.
The fruition of this recurring revenue model is evident in Microsoft’s steadfast revenue growth, which surged by 16% in the most recent quarter, despite declines in video gaming and PC hardware.
Conversely, Costco’s profit engine hums at a net margin close to 3%, while Microsoft shines as one of the most profitable entities in its competitive landscape, boasting an operating profit that amounts to 44% of sales — a figure that handily overshadows industry peers like Amazon and Apple.
MSFT Operating Margin (TTM) data by YCharts. TTM = trailing 12 months.
Microsoft further flaunts its financial robustness through burgeoning cash flow reserves, tallying $81 billion as of early 2024 and notching a $19 billion inflow in the recent quarter, dwarfing Costco’s $5 billion. This discrepancy underscores the unparalleled and efficient revenue generation stemming from Microsoft’s dominant position in the highly lucrative software domain.
The Price Conundrum
While Microsoft’s stocks demand a premium, priced at 14 times its sales in comparison to Apple’s 8, the swelling valuation underscores the market’s optimism toward the potential impacts of artificial intelligence on software demand. This bullish sentiment, however, orbits the risk of an overvalued purchase that could potentially undershoot shareholders’ expectations in the event of an AI market downturn or a misstep in Microsoft’s aggressive pursuit of AI industry leadership.
Nevertheless, despite these pitfalls, Microsoft promises substantial long-term value for investors, overshadowing any temporary hesitations about the premium price tag.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Demitri Kalogeropoulos has positions in Amazon, Apple, and Costco Wholesale. The Motley Fool has positions in and recommends Amazon, Apple, Costco Wholesale, and Microsoft. The Motley Fool has a disclosure policy.