Microsoft: Peak Tech Bubble 2.0?

 

 

• Strong Earnings and Financials Make Microsoft (MSFT) a Winner Versus Peers
• Technology Sector Valuations Extremely High, Heightening Risks of Substantial Correction
• Salesforce (CRM) Acquisition Could Prove Lackluster, Reminding of Ugly Nokia (NOK) Write-Off

With the latest buyout spree raising concerns that another crash in stocks is around the corner, technology stocks are some of the most vulnerable considering valuations.  Although some asset managers, notably David Tepper, are making the case for going long stocks by stating “don’t fight the Fed…now you’ve got four Feds,” this strategy is not without risks.  On the other hand, you have the actual Federal Reserve Chair Janet Yellen highlighting yesterday in prepared remarks that “equity valuations at this point are generally quite high” before taking it one step further by lamenting “there are potential dangers there.”

Microsoft (MSFT) is a name with recognition around the globe.  Almost everyone who has used a personal computer at one point has used either the company’s operating system or program suite.  Their development, sales, and support for a range of software products makes them an integral piece of the global technology sector.  Nevertheless, their status as a global technology leader will not prevent a sizeable correction to valuations should monetary policy meet its limit or investors fear the bubble in stocks beginning to burst, reminding investors of the experience in the early 2000s.

Earnings Beat Adds to Price Momentum

Despite the optimism surrounding Microsoft stock, shares are trading slightly negative year-to-date.  The company, which is a component of the Dow Jones Industrial Average, trades on the NASDAQ (QQQ) with many other technology stocks.  Shares are trading just 7.50% off of 52-week highs and not far from all-time highs reached in December of 1999 (just before the last technology bubble burst).  Earnings themselves have remained strong in a difficult environment for the industry as evidenced by the announcement on April 23rd in which earnings printed at $0.62, beating estimates of $0.51.  The earnings announcement gave investors a sigh of relief after the company declared a dividend of $0.31 per share. 

Not only have shares prices doubled from crisis-lows, but the company has consistently grown its dividend over the last five-years, offering great value to shareholders.  However, while the results are optimistic, the company is not without risks to the outlook.  While the shares themselves have tremendous value simply based on the revenues of the company and strong margins, a price-to-earnings ratio over 18 is just not sustainable for a technology institution that would no longer be necessarily considered high-growth.  Although cloud services are forecast to play an increasing role in the company’s revenue generation, the company has been forced to write down the value of the Nokia acquisition not to mention other strategic business blunders in the last few years.  The latest comments about a possible bid for Salesforce could possibly add to the string of bad acquisitions instead of adding value.

Salesforce Bid in the Wings

Microsoft and Salesforce already have a partnership, meaning that a bid for the business would be quite normal considering the existing relationship.  However, at the proposed $50 billion, the valuation might be a little rich, even for Microsoft which has seen its own cloud services momentum speak for itself.  The company’s business is quite viable against other very formidable competitors in the cloud space including Google (GOOG) and Amazon (AMZN). Not only that, the company has had to write off the value of other past acquisitions that ended up proving headaches, namely the purchase of Nokia (NOK) which has added to the woes of an already struggling mobile phone unit.  Microsoft is on the cusp of becoming hip again and with the introduction of new products and services, the Salesforce acquisition would likely hurt that momentum, just as the company is making great strides to improve its core businesses.

The Technical Take

Microsoft shares have risen sharply in the post-earnings environment owing to a substantial beat of expectations, future growth aspirations from cloud services, and the newly announced HoloLens.  The company’s stock rose nearly 10% on the earnings exuberance, hearkening back to investor excitement witnessed in the 1990s in the run up to the technology bubble.  The latest technical correction in prices is warranted given the tremendous moment higher within a very short period of time.  From the perspective of charts, technical indicators are providing mixed signals.  On the one hand, the latest rally shows that substantial resistance sits just around the $50 level, creating the impression of a double-top formation when compared to the November 14th high. 

Although shares are trading above both moving averages, the 50-day moving average crossing the 200-day moving average to the downside in March is a bearish sign.  For confirmation of a more bearish bias in prices, it will be relevant to watch if prices fill in the gap higher from the earnings announcement.  If the gap is filled near $43.32, there is strong potential for the correction to persist, with prices targeting $40.18.  Any break below this key support level could pave the way towards prices in the high $30s depending on how the broader market is reacting.  However, if the 50-day moving average manages to cross the 200-day average to the upside, the current weakness in share prices might quickly reverse for a retest of resistance at 52-week highs.

Conclusion

As a long-term holding, Microsoft is a great technology component for any diversified portfolio.  The company’s core businesses continue to grow and the addition of new technologies paves the way for sustainable expansion down the road.  For income investors, the growing dividend makes a very compelling argument for purchasing the stock.  However, on a short-term basis, when valuations are tremendously high, there is strong probability that trades with a briefer time horizon are risking a particularly painful trade to earn a few extra percent gain, not exactly smart investing.  Comments from the Federal Reserve on the extended valuation of stocks is not helping the argument for holding in the near-term.  However, on a long-term basis, buying any substantial correction of 20-25% off of recent highs would be prudent considering the strong outlook for company between potential earnings and dividends.