Why Did David Tepper Buy Microsoft?

Billionaire David Tepper is among Wall Street’s most respected hedge fund managers. Heading the Appaloosa fund, Tepper has more than $5.5 billion of assets under management.

The second-largest position in the Appaloosa portfolio is Microsoft (NASDAQ:MSFT), which accounts for 11.3% of the fund’s holdings.

Why is Tepper so heavily invested in Microsoft, and is the stock still a good investment at today’s prices?

Understanding Tepper’s Investment Approach

To understand why David Tepper bought Microsoft, it’s important to examine his approach to investing and how he evaluates companies.

Looking at the Appaloosa portfolio, it quickly becomes clear that Tepper is currently all-in on large market cap fast-growing, and high margin technology stocks.

The top 10 holdings in the fund, making up over 70% of the total, are as follows:

• Meta
• Microsoft
• Amazon
• NVIDIA
• Uber
• Alibaba
• Alphabet
• AMD
• Intel
• FedEx

In spite of this, Tepper isn’t exclusively a growth investor like Cathie Wood. In fact, his approach is much closer to traditional value investing. Typically, he specializes in identifying undervalued or distressed companies and buying them at steep discounts to their intrinsic worth.

This suggests he sees untapped value in Microsoft and other tech companies, even though many of these stocks trade at high prices today.

Tepper is well-known for concentrating his portfolio, an approach that has served him well in the past. Given that Microsoft makes up more than 10% of Appaloosa’s holdings, it seems safe to assume that he has identified it as a stock that is worth taking a concentrated position in.

Why Did David Tepper Buy Microsoft?

Microsoft has an enormous moat and very high margins, even eclipsing Apple’s which are primary reasons David Tepper bought the stock.

Bill Gates’s company is an undisputed giant with an enormous moat in the software industry. Among desktop computers, for instance, Windows is still by far the dominant operating system with a market share of 72.5%.

Microsoft Azure enjoys a 15.5% share of the cloud computing market, and more than 80% of Fortune 500 companies rely on Microsoft Office 365 for their business software needs.

Microsoft also appears to be a good value considering its pricing and future growth potential. At 35x forward earnings and 14x sales, Microsoft isn’t what you might classically think of as an undervalued stock.

With earnings expected to compound at almost 14% annually over the next 3-5 years, though, the company can likely deliver enough growth to justify its premium pricing.

It’s also worth noticing that Microsoft trades at lower multiples than other leading tech stocks. NVIDIA, for instance, is priced at an even more aggressive 39x forward earnings and 36x sales.

Adding to this thesis is Microsoft’s strong financial position. The enterprise’s debt-to-equity ratio is just 0.2, and the company maintains a cash reserve of nearly $81 billion.

With those deep pockets, Microsoft can invest in new products, advance internal growth initiatives or make strategic acquisitions. CEO Satya Nadella has also been progressively reducing its long-term debt since 2017, making it more financially secure as the years have gone by.

Microsoft also has a massive opportunity in front of it as a leader in AI. While other major companies like Meta and Palantir hope to ultimately take the lead position in artificial intelligence, Microsoft is the clear early front-runner.

Microsoft invested in OpenAI, the company that created ChatGPT, a partnership that allowed Microsoft to seize a lead on other companies in the AI space. The approach seems to be paying off, as new AI tools were credited with much of Microsoft’s 17% revenue growth in Q1.

This potential to become a dominant force in AI is enhanced by Microsoft’s existing products. Microsoft Azure, for example, provides a nearly perfect platform for introducing the company’s new suite of AI apps to a large base of existing customers.

Added functionality from ChatGPT has also allowed the company’s Bing search engine to attract a slew of new users over the past year.

Even though Google remains the dominant search engine, Bing’s increased usage could allow Microsoft to gradually raise advertising revenues and increase usage of its other products.

A final factor that may have made Tepper decide to invest so heavily in Microsoft is its status as one of the first technology majors to move toward offering dividends.

Although Meta and Apple have made more recent moves to distributing cash, Microsoft has been actively increasing its dividend for 22 years. Given its rapidly increasing earnings, Microsoft remains a prime candidate for long-term dividend growth, let alone share price appreciation.

Should You Follow Tepper Into Microsoft?

One thing investors should understand about the Appaloosa position in Microsoft is that it has a low cost basis compared to today’s prices.

Tepper’s earliest transactions in MSFT stock goes back to 2012. Though the billionaire has bought and sold the stock over the years, about 1.5 million of the 1.7 million shares owned by Appaloosa were bought in 2023. The average purchase price was around $286 per share, well below today’s price of about $406.

Even though today’s investors have to pay a slightly higher average price than David Tepper did for his Microsoft stake, the company still appears to be a reasonably good buy.

Microsoft enjoys a combination of an excellent moat, financial strength and strong growth opportunities. Even at higher prices, Microsoft’s strengths make it undeniably an attractive business.

Looking forward, analysts project MSFT hitting a target price of $475, implying a gain of about 17%. Even if MSFT doesn’t go quite that high, it is likely to still handily outperform the market over the long-term.

In the shorter term, the S&P 500 is expected to rise by about 7% over the coming year, less than half of the gain expected from Microsoft.

Ultimately, Microsoft still appears to be a fairly strong buy. There is still room left for investors to see strong returns this year, and the company’s long-term prospects are more than strong enough to make it a good multiyear compounder if growth continues as expected.

Continued dividend growth could even make Microsoft a good income-generating stock, though it’s likely that the yield will remain fairly low for the foreseeable future as the company continues to invest into more productive growth initiatives.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.