Michael Kramer and the clients of Mott Capital own MSFT.
Microsoft Corp.’s (MSFT) stock has fallen about 11% since peaking on September 2, but that may only be the beginning. The stock could be heading even lower. Perhaps, by as much as 10% more based on an analysis of its technical chart.
Still, despite the recent pullback, the shares are up more than 35% on the year, easily outpacing the S&P 500 gain of 6.1%.
The stock broke a technical uptrend on the chart, which has acted as support during the equity’s significant advance since early April. The breaking of that uptrend signifies a substantial reversal of the trend and suggests the stock has further to fall. Currently, the next significant level of support for Microsoft does not come until the stock reaches $198. If that level of support breaks, it would indicate the stock is heading lower towards $188, a drop of about 10% from its current price of $208 on September 8.
There is a strong chance the stock ends up breaking support at $198 and heads to $188. That is because the relative strength index, a measure of a stock’s momentum, has fallen to its lowest levels since late March, and an indication that momentum in the stock is quickly shifting from bullish to bearish.
The bigger problem the shares face is that their current valuation is not cheap, and the shares may need to slip further before pulling in investors looking for a bargain. Currently, the equity trades for 29.2 times one-year forward earnings estimates, which is its highest earnings multiple since 2002.
The bigger problem with the stock over the short-term is that earnings growth, although reasonable, will likely not be fast enough to support the lofty earnings multiple. Analysts currently estimate that earnings will increase at a compounded annual growth rate (CAGR) of about 13% over the next three years. That gives the stock a 3-Year CAGR adjusted PEG ratio of about 2.2.
On both of these fronts, the stock is not cheap and would need to fall sharply to get back to a more reasonable valuation. Over the past 5-years, the stock has traded with an average PE ratio of about 21.9 times one-year forward earnings estimates. Additionally, we have seen that ratio move higher over time, with the 1-year moving average PE climbing to 27.1. At the lower valuation, the stock could trade in a range of $161 to $198.85, respectively.
With Microsoft’s momentum beginning to run out, and a valuation that appears to be stretched, lower prices may lie ahead for the equity. But that does not mean that the company will not have a bright future because analysts estimate plenty of sales growth down the road. With revenue expected to rise to $194.0 billion by the fiscal year 2023 from $143.0 billion in fiscal 2020, a CAGR of about 10.7%.
Unfortunately, the stock may have gotten too far ahead of itself during the technology-led rally we have witnessed in the equity market. Now the equity will need some time for its fundamentals to catch up with those lofty valuations.
Michael Kramer is a financial market strategist and the portfolio manager of the Mott Capital Thematic Growth Portfolio.
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