Microsoft's Responsibility in ESG Investing: A Examination

Exploring ESG Investments: Does Microsoft Measure Up as an Ethical Option?

When Bill Gates and Paul Allen established Redmond, Washington-based Microsoft (MSFT 1.14%) in 1975, their goal was to create a BASIC interpreter for the Altair 8800, improving personal computing hobbyists' utilization of the groundbreaking machine.

Fast forward nearly five decades, and Microsoft ranks as the second-largest company globally by market capitalization, exceeding $3 trillion. The tech powerhouse employs more than 228,000 individuals worldwide. Its product lineup includes operating systems for PCs (Windows), video games (Xbox), software developer tools (Visual Studio), laptops and tablets (Surface), search engines (Bing), productivity suites (Office), social media platforms (LinkedIn), and a robust cloud platform (Azure). Collectively, these offerings generated $88.1 billion in net profit and $118.5 billion in net cash from operations on a $245.1 billion in revenue for fiscal year 2024.

Microsoft has grown significantly since its inception. Current CEO Satya Nadella, handpicked by Gates and his predecessor, Steve Ballmer, during Ballmer's retirement, has always been determined to elevate Microsoft to the position of world leader in Environmental, Social, and Governance (ESG) practices - an investment strategy used by investors in alignment with their values.

In recent years, Microsoft has garnered numerous placements on ESG-related lists, such as being named one of the 100 Best Corporate Citizens, earning a 100% rating from the Human Rights Campaign Corporate Equality Index, and boasting an AAA rating from MSCI ESG Ratings.

The reasons for these recognitions and high rankings are evident. For years, Microsoft has published a comprehensive sustainability report which adheres to the Global Reporting Initiative (GRI) Sustainability Reporting Standards, as well as the United Nations' disclosures for reporting on human rights and progress under the UN Global Compact. To evaluate if Microsoft is an ethical investment, let's examine its performance using a 10-question ESG framework.

Ten-question ESG framework

1 - 5

1. Does the company treat its employees well?

Yes. Three of the nine factors outlined in its sustainability report, which Microsoft claims affect its business, pertain to workplace treatment: accessibility, ethical business practices, and human capital. The humane and respectful treatment of employees is a core value to the company.

Microsoft ranked 18th on Glassdoor's 2024 Best Places to Work while ranking as the 42nd best-led company in 2024. Overall, Microsoft is a premier employer that prioritizes employee well-being. Microsoft has a reputation for retaining employees and promoting them into leadership roles. Nadella is just one example.

2. Is the company a good steward of the environment?

Yes. Environmental responsibility is central to at least three of Microsoft's nine nonfinancial material factors affecting its business:

Utilizing technology for environmental and social benefits.
Climate change and energy.
Sustainable sourcing and device lifetime impacts.

Data centers, due to their constant demand for electricity to transfer data globally at high speeds, can contribute to significant pollution. This process also generates heat within servers, necessitating additional power consumption for cooling. This vicious cycle can result in excessive power consumption.

Microsoft is countering these challenges by partnering with leading low-carbon energy companies to power its data centers. In 2024, it signed the largest-ever power purchase agreement (PPA) with Brookfield Renewable (BEP 0.39%)(NYSE:BEPC). It also entered a PPA with Constellation Energy (CEG 4.04%) to buy all the power from a nuclear power generating unit the company intends to reactivate.

The sheer scale of Microsoft's data center endeavors is noteworthy, given the importance of its green initiatives. With already 36 countries hosting Microsoft operations or data centers for its Azure cloud computing service, the company has 300 data centers and is actively building more.

3. Does the company promote diversity and inclusion?

Yes. Microsoft is considered a distinguished corporate citizen, receiving recognitions for diversity, inclusion, belonging, and sustainability (DIBS). In 2023, it received a 100% rating from the Human Rights Campaign Corporate Equality Index, and was designated as one of the "best places to work for LGBT Equality."

Microsoft has made significant efforts to become more diverse and inclusive over the years. In 2023, women constituted 31.2% of its core workforce, a 3.6 percentage point increase since 2019. Moreover, racial and ethnic minorities accounted for 54.8% of the company's core workforce, a 1.5 percentage point increase from the previous year.

4. Does the company have ethical corporate governance principles?

Yes. Microsoft adheres to important ethical governance standards for a shareholder-friendly board.

5. Do the company's business model and investments align with ESG principles?

Yes. Microsoft generates revenue by offering desktop and mobile software primarily through subscription-based services, delivered via the cloud, to billions of individuals worldwide. Its financial reporting is divided into three segments:

Business and Operations for handling products like Excel and Word under the Office brand, for marketing Dynamics business analytics software, and for offering LinkedIn's services for connecting professionals with opportunities.
Cloud Services for providing access to the Azure public cloud and the developer tools for building and maintaining modern, cloud-based applications.
Computing and Consumer Goods for selling Windows licenses to hardware manufacturers, for selling Surface devices, for selling Xbox gaming products, and for managing the Bing search engine.

Microsoft is expanding its investments in cloud offerings to meet these needs. Responsible Investment Advocates will appreciate this trend. In the future, Microsoft is targeting complete reliance on renewable energy sources.

6 - 10

6. Does the enterprise hold a balanced financial status?

Indeed. Microsoft boasts one of two U.S. companies with a triple-A credit rating. This is primarily due to its significant cash reserves, consistent revenue, substantial cash flow generation, and product relevance.

Critics might accurately point out that Microsoft has around $50 billion in debt, rendering it debt-laden but not debt-free. However, it also maintains more than $75 billion in cash reserves. Additionally, it intelligently utilized low-cost debt funds for constructing eco-friendly business facilities and building energy-efficient data centers.

7. Can the company produce organic revenue growth backed by long-term market trends?

Yes. Microsoft either leads or has a significant impact on most market segments in which it operates. Its substantial advancement in artificial intelligence (AI) is the outcome of its partnership with OpenAI. It's integrating AI into Azure, Bing, and other projects, positioning Microsoft to continue growing at a healthy pace in the ensuing years.

8. Can the business produce growing free cash flow and maintain high profitability?

Yes. Microsoft recorded $23.3 billion in free cash flow (FCF) during the fourth quarter of its 2024 fiscal year, an 18% increase over the previous year. Microsoft's consistent and growing free cash flow allows it to expand its business, enhance its dividend, and repurchase shares.

The company has also delivered consistently increasing return on invested capital (ROIC) in recent years. Its ROIC has exceeded 25% in recent years, an increase from the mid-teen rate it recorded in earlier years. Microsoft's investment in cloud computing, gaming, and AI is proving successful.

9. Is the management committed to fostering long-term, profitable growth?

Yes. Microsoft continues to allocate substantial capital to areas it believes will drive profit growth in the long term. Notable growth drivers include gaming (it acquired prominent game maker Activision in 2023), AI, and cloud computing. Its investments have continually boosted the company's revenue, earnings, and cash flow at healthy rates, which should continue into the future.

10. Does the company have a moderate or lower risk profile?

Yes. Microsoft has a lower risk profile. This technology giant is a highly profitable enterprise with generous cash flow. The company produces more cash than it needs for operations, allowing it to return cash to investors through dividends and share repurchases.

Microsoft also maintains a formidable balance sheet. The company has an outstanding credit rating and a substantial cash position. This grants it considerable financial flexibility.

It's also active in expanding industries. Microsoft is a prominent player in cloud computing and an emerging leader in AI. This positions it to continue growing its revenue and profits in the future.

However, it's not to say that Microsoft is devoid of risk. Given its enormous size, it's facing increased regulatory scrutiny, making it more challenging for Microsoft to make significant acquisitions (it nearly failed to complete its acquisition of Activision due to regulatory issues). If regulators perceive Microsoft as having gained too much market dominance, they might force the company to divide.

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Microsoft is an ESG leader in performance

Microsoft scored a perfect 10 on Our Website's ESG Compounder Checklist, which is an impressive result. Although the company can improve in certain areas, such as diversity and inclusion, it's a top ESG stock.

In light of Microsoft's comprehensive sustainability report, it actively prioritizes the ethical treatment of its employees, earning a 18th place on Glassdoor's Best Places to Work list and being recognized as a premier employer. In alignment with ESG principles, Microsoft has a diversified business model that primarily generates revenue through subscription-based services delivered via the cloud, and it has a substantial commitment to environmental responsibility, partnering with leading low-carbon energy companies to power its data centers.