Microsoft (MSFT) started 2022 with a slight dip, along with many tech stocks and Nasdaq in general. The stock is currently 10% off all times Average $350 and some analysts are already hitting the table for key moment use. We ask, “What crucial moment?” Sure, the Wedbush piece didn’t just focus on Microsoft but it was the stock that got the most attention as seen in the comment flow for the linked news article. We love stocks but the 10% on the back of 500% since 2017 doesn’t exactly look like a bargain, let alone a defining moment.
In this article, we evaluate some of the pros and cons and give you a good point and options strategy that we recommend to use on stocks that you would like to own but at a cheaper price. Let’s start, ruling out the negatives first.
No: history can repeat itself
Microsoft has been around for a long time at this point which goes by every name in the book when it comes to stock ratings. From being a startup to a company with growing pains to a massive growth stock to a 15 year lag to being a massive growth stock. Along the way, the company has also become a 60% dividend aristocracy as its annual dividend has increased 15 years.
Skeptics would argue that Microsoft spent 15 years on its way to nowhere after the explosive growth of the 1990s and there is no guarantee that history may not repeat itself after its recent growth spurt. In our view, this is unlikely because the main reason Microsoft has fallen into a deep slumber is the lack of a meaningful competitor in the age of operating systems. In the age of the cloud and the Metaverse, many other whales might eat Microsoft lunch at the slightest hint of complacency.
Nope: Multi-compression Ultimate
Some of the biggest stocks in the past, including Microsoft from legacy systems and Cisco Systems (CSCO), have posted impressive earnings growth. What made the returns (after massive runs) anemic was the “multiple stress”, as earnings rose but expectations were so high that the market started giving the stock a lower multiple, causing the stock price to stagnate or fall.
Typically, future estimates are compiled based on estimates of the next fiscal year’s earnings. Mr. Markt is usually not very patient. But looking at Microsoft’s recent run and its quality, let’s see what’s doubly ahead [PE] Based on FY 2024 earnings estimates. With expected earnings per share of $11.93, Microsoft is trading at a multiple of nearly 27 based on FY 2024 estimates. A lot can happen between now and 2024 and that multiplier doesn’t seem cheap. Sure, based on a well-chosen comparison, this might sound cheaper but we wouldn’t be surprised by either of these two scenarios (or both): high earnings expectations prove too high or the market doesn’t award high multiples, even to a recent winner like Microsoft.
(Source: Find Alpha)
Yes, you read that correctly. Microsoft is not one of the two names that come to mind when talking about the Metaverse. This distinction belongs to Meta Platforms (FB) and Nvidia (NVDA). But Microsoft’s entry into the Metaverse only makes sense given its presence in our daily lives, especially the official side of it. Teams from Microsoft is a collaborative tool that is becoming more and more popular since the COVID pandemic began. Microsoft takes Teams to the next level by introducing “Mesh,” which it believes will be the gateway to the Metaverse. Mesh will introduce avatars to make meetings more personalized and “To transport their avatars into immersive spaces to experience those chance encounters that spark innovationClick here for more information on this in Microsoft’s own words.
In this article, SA author Jonathan Weber argues that Microsoft’s serious commitment to the Metaverse will add a spark to its stock.
Yay: Quality wins
Whenever tech sells off and market makers decide to buy tech stocks and ETFs, Microsoft will rightfully be one of the first names to catch the eye.
Research on Alpha’s quantitative ratings provides confirmation of the high quality of the stock in many aspects including profitability, momentum and earnings as discussed below. Understandably, the dividend gets D+ as the stock’s massive rise in price lowers the return. But keep in mind that Microsoft has been increasing its dividend every year since 2006 and the five-year dividend growth rate is an impressive 9.40%. In other words, the low return is not because the company cannot or will not increase its dividend but because the stock price has exceeded expectations.
The D-score rating is not surprising as the market has been striving for high growth names over the past couple of years. We believe that the stock is still further down here and may see a $200 rally (say $280 to $290) before rebounding.
The D+ growth score is a bit worrisome but looking at the details here, the three important metrics under growth: revenue, EPS, and free cash flow are all significantly higher than the segment. However, given the growing valuation and general optimism about earnings, multiple pressures would be normal when increasing earnings.
(Source: Find Alpha)
ALTERNATIVE WAYS TO BUY: Consider Selling Offers
If you want to get Microsoft but at a lower price, selling might put you best ally. Many long-term investors generally view options as risky and complex. However, once the risks are understood, options can go hand in hand with both basic and long-term investing. Hard to believe? Even the “buy and own” investment god, Warren Buffett, has used this strategy successfully.
Consider selling only under these conditions (all three must be met):
- The underlying stock is the thing you wish to own, if assigned.
- The strike price is something you feel comfortable with.
- Your sells are cash-secured, which means you have enough cash to buy the underlying stock if the strike price is met on the expiration date.
Thanks to the readers of our previous article on Bid Sale, please be wary of known company-specific events such as the ones below before the sale bid:
- The next dividend date before the put option expires, as the amount of the dividend is deducted from the stock price brings the stock closer to the option’s strike price. Microsoft will have two prior dividend events between now and the expiration date of the series of options that we describe below. But given the small return (62 cents on a $314 share), the quarterly dividend being deducted from the stock shouldn’t make much of an impact in this case.
- The release of upcoming earnings near the option’s expiration date, with increased volatility. Microsoft will report two quarterly earnings in this time frame.
Below is a mode that we rate on Microsoft. To explain it in plain words, we need to set aside $28,000 so that we can buy 100 shares of Microsoft at a strike price of $280. Mr. Market is willing to pay a premium of $1,240 for this. That’s a return of 4.50% in 6 months on the $28,000 we need to set aside for this contract. In general, we prefer options that expire in a month or two, but we strongly believe that Microsoft’s approximate start to the year isn’t over yet.
Going back to this example,
- If Microsoft exceeds $280 when the option expires on July 15, 2022, that position will expire worthless and we retain a premium of 4.50%, which is more than 5 times the current EPS.
- If Microsoft trades for less than $280 when the option expires on July 15, 2022, we will be obligated to buy 100 shares at $280, regardless of the market price at that time. However, adding the premium, the breakeven price for this trade is $267.60 ($28000 minus $1240 divided by 100 shares).
- There is also a third method by which this chain of options can be closed out, it is called “buy to close” where if we think we have made a large portion of the premium, we will close the position before July 15, 2022, and repeat the process with a different expiration/execution price combination.
Why are we looking at the $280 price range?
At this point, you might be wondering why we used the $280 price range so many times in the article. Here you are.
- $280 to $290 would be our preferred entry point from a technical point of view as that represents the stock’s 200-day moving average.
- $280 represents a 20% sale from an all-time high of $350. Selling 20% is a bear market and a strong stock like Microsoft is unlikely to stay in that territory for long, if it ever gets there in the first place.
- $280 is also 10% less than the current share price, which guarantees a relatively margin of safety.
To repeat the cliched phrase, price is what you pay and value is what you get. We definitely see the value in Microsoft, the company. But the price is not yet up our alley. We continue to hold our existing shares (including our dividends) and will add to the stocks on a meaningful pullback. Until this event, the sale offers us a compromise to stay in the names we love while not missing out on the whole game.