Microsoft’s Stocks Faces Even Steeper Declines

Michael Kramer and the clients of Mott Capital own MSFT.

Microsoft Corp.'s (MSFT) stock has fallen by a staggering 27% from its peak on February 10, while the S&P 500 has fallen a jaw-dropping 32% over that same period. Investors are dealing with the harsh reality that the rapidly spreading coronavirus is likely to cause a massive slowdown to the US economy in the months ahead. That fear has sent the stock market plunging, and it may still even have further to fall, and Microsoft will likely not be spared.

The company revised its third quarter guidance on February 26, noting that its More Personal Computing segment was not going to meet its prior revenue forecasts. The company had previously been forecasting revenue from the unit of $10.75 billion to $11.15 billion. However, analysts have been slow to adjust their revenue targets for the quarter, and that could mean earnings estimates are too high. It also means that the stock's current price-to-earnings ratio needs to fall further, making the equity potentially overvalued during this uncertain time.

Estimates May Need To Come

Currently, analysts see revenue in the fiscal third quarter at $34.35 billion and have lowered their estimates by just 72 basis points over the past 30 days. Meanwhile, earnings estimates have fallen by only 1.5% over that same period to $1.31 per share. But the company didn't give a new guidance range, which suggests the company doesn't have a clear vision in the current environment. It could mean that estimates are still too high and will need to fall further.

Full-year revenue and earnings estimates have remained relatively unchanged over the past month as well. Currently, earnings are estimated to rise by roughly 18.9% in fiscal 2020 to $5.65 per share, while revenue is forecast to climb by 13.0% to $142.21 billion. But again, with all the uncertainty in the current landscape, it seems that estimates could be negatively impacted.

Earnings Multiple May Be Too High

But despite all the question marks around the future, the stock continues to trade with what appears to be a historically high one-year forward PE ratio of 22. In the unexpected declines of 2018, that PE ratio fell to as low as 20, and in mid-2016, it was as low as 16.1. Should the equity’s earnings multiple continue to contract and move to the lower end of that historical range at 16.1, the shares could fall to as low as $100.50 based on current estimates for next year of $6.24 per share.

Technical Take

The technical chart does show that the equity is currently trading in a region of support that appears healthy, between $130 and $140. However, should the stock fall below $130, the next significant levels of support do not come until $124 and then $112. That would amount to a further decline of about 18.5% from the stock's current price of about $137 on March 20.  The relative strength index has fallen to around 40 but has yet to fall to 30 or lower. It means that despite the stock's steep decline, the shares are still not oversold, and could fall even further.

With all the uncertainty in the world, it seems that Microsoft's stock should likely be trading at a one-year forward earnings multiple that is closer to the lower end of its historical range. It means that the stock is likely not finished falling yet.

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

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