Microsoft (MSFT) has declined since reporting the results, but declines may only be starting. The drop came despite having released powerful fourth quarter fiscal results. Still, the revenue guide was only aligned, and that’s just not good enough for a stock that is trading at such a high valuation.
The results have caused options traders to start circulating, and it appears they are betting that the stock continues to decline. Meanwhile, stocks are very close to breaking a very significant technical level.
Big Premium
Stock valuations had soared to levels not seen in nearly 20 years before reporting results, trading at nearly 35 times its one-year earnings estimates. That has dropped a bit since then, to around 27.6, which is still very high. While it makes sense why investors have flocked to Microsoft for its security and balance sheet strength, it doesn’t mean its valuation hasn’t been extended.
The problem is that the company gave a guide that was in line with a little more than expected. Analysts had been looking for first-quarter tax revenue of $ 35.9 billion. But the company guided the quarter into a range of $ 35.15 billion to $ 36.05 billion, resulting in the midpoint of the range falling below expectations.
The slightly weaker orientation was due to a major flaw in their productivity and business processes. The company asked for a range of $ 11.65 billion to $ 11.9 billion compared to expectations of $ 12.1 billion.
(Refinitiv)
The slightly weaker / online outlook probably gave investors the warning they needed, which was that expectations had become too high in the stock, and the company was unable to meet them.
Looking for a decrease
That’s probably why some traders are now betting that the stock will drop in the coming weeks. For example, the open interest for August 21, calls of $ 220 increased by approximately 7,800 contracts on July 24. It looks like a bullish trade, but digging deeper into the data, we see that these calls traded on the bid, a sign that they were sold. It is likely to be part of a hedged buy strategy, where the owner of the stock seeks to improve his returns, while the stakes do not increase beyond $ 220 by the expiration date.
Additionally, sales of $ 175 on September 18 increased by approximately 6,200 contracts. The data showed that these contracts were traded on the ASK and bought for around $ 2.10 per contract. It is a gamble that the stock falls below $ 173 in mid-September, a drop of about 14%.
A technical upward trend is approaching
But what may be more important is that Microsoft is very close to falling below a significant level of support. The technical chart shows that a bearish pattern formed at Microsoft known as a hit and a run. The stock has already broken the high bullish trend in the pattern and is now very close to breaking the lowest bullish trend. If that trend line breaks at $ 197, the stock is likely to drop back around $ 187.
We can also see that the momentum in the stock is declining, the relative strength index has been gradually falling and is now at its lowest point since April. I would suggest that the bearish momentum is taking over.
Long-term vision
There is nothing wrong with Microsoft’s earnings or stocks, only that the valuation had been brought forward. The results were much better than expected and the orientation was basically online. But when investors are paying a high multiple for equities, expectations are for guidance that is much better than consensus.
Risks
The most significant risk based on the analysis is that markets continue to crawl higher, and if that happens, Microsoft is likely to recover. Just because an equity is overvalued today does not mean it cannot be overvalued tomorrow. It is unknown how long investors will be willing to pay for high quality stocks.
If valuations become important to investors again, stocks are likely to decline over a period.
I love this article? Then hit the follow button at the top of the story!
Live webinar on July 30: Register now to participate! 9 pm ET
Let the market be your guide
Thinking about the next big move on the market is never easy, so let me help you determine what that move will be. Every day, Reading The Market uses changes in the fundamentals, technicals and options markets to determine the next significant move in stocks, sectors and indices.
For more information, visit our home page
Divulge: I am / we are long MSFT. I wrote this article myself and express my own opinions. I receive no compensation for it (other than Seeking Alpha). I have no business relationship with any company whose shares are mentioned in this article.
Additional disclosure: Mott Capital Management, LLC is a registered investment advisor. The information presented is for educational purposes only and is not intended to make an offer or request for the sale or purchase of specific securities, investments or investment strategies. Investments involve risks and, unless otherwise stated, are not guaranteed. Be sure to consult with a qualified financial advisor and / or tax professional first before implementing any strategy described in this document. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.
