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Microsoft’s Expensive Stock May Still Climb Higher

This article is more than 4 years old.

Michael Kramer and the clients of Mott Capital own MSFT.

Microsoft Corp.’s (MSFT) stock has risen by roughly 12% since reporting fiscal first quarter 2020 results on October 23. Now some traders are betting that the stock’s recent success isn’t over and that the shares climb even higher by the middle of January. The big post earnings move has resulted in the equity’s valuation rising as well, leaving the shares at the upper end of its historical valuation. It would suggest that further upside may be limited.

The company reported better than expected first quarter results, with earnings beating estimates by nearly 11%. Additionally, the company had better than expected revenue, which also topped analysts’ forecast by 2.5%.  The better than expected earnings have resulted in analysts lifting their full-year estimates.

Reaching Overbought Prices

The equity rose above a level of technical resistance on October 28, when it climbed above $142. It sent the stock sharply higher towards its next technical level of resistance at $152 over the next few weeks. The current price appears to be an area where the stock may pause and consolidate. That is because the stock is overbought with a relative strength index (RSI) currently at 72. When the RSI rises above 70, a stock is overbought.

Still Further To Climb?

Despite the stock being overbought short-term, some options traders are betting that the stock continues to climb. The open interest for the January 17, 2020 call options has increased by over 25,000 contracts since November 21 to over 67,000 open contracts. The contracts trade for roughly $5.00 per contract as of November 29. That means for a buyer of the calls to earn a profit; the stock would need to rise to $155 or higher by the expiration date, a gain of 2% or more over the next two months.

However, some traders are betting the stock rises even higher, with the open interest rising at the calls for expiration on January 3 for the $157.5 strike price. For a buyer of the calls to earn a profit the stock would need to rise to $158.5 or more, a gain of at least 4%.

Earnings Estimates Are Rising

The reason for the optimism stems from the better than expected results at the end of October. It has resulted in analysts raising their full-year earnings estimates for 2020 by 2.3% to $5.39 per share. Meanwhile, estimates for fiscal 2021 have risen by 2.2% to $6.05, and by 4.8% to $6.98 per share.

Valuation Is Approaching The Upper End of the Range

Even with the rising estimates, the stock's valuation continues to climb, with the shares trading at 25 times one-year forward earnings estimates. It places the stock at the upper end of its historical range from 2016 of 16 to 27. The high valuation means that the equity needs further multiple expansion to see the stock rise significantly from its current price. At 26 times 2021 earnings estimates, the stock would trade for roughly $163, about 7% higher than its current price.

While Microsoft’s rally is poised to continue, the upside from its current levels may be limited over the longer-term.

Michael Kramer is a financial market strategist and the portfolio manager of the Mott Capital Thematic Growth Portfolio.

Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. 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.

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