Over the past decade, Microsoft's (NASDAQ:MSFT) shares have gone nowhere. If not for the predictable and reliable dividend, many investors would have thrown in the towel and given up ownership years ago. Rather than providing a product review of Windows 8 or comparing Microsoft to Apple, I intend to exhaustively and quantitatively analyze the factors which actually drive share price and provide actionable analysis to the prudent investor. Through this article, I will fundamentally, statistically, and technically analyze Microsoft and recommend that investors consider shorting the security or exiting shares in the near future.
Prior to making any sort of investing recommendations, investors must first fundamentally analyze a security. In order to exhaustively examine the history of Microsoft, I have relied heavily on return on assets and return on equity. Return on assets is the net income of the firm divided by average total assets across an operating cycle. This key metric allows an investor the ability to understand how efficiently an organization uses its assets to generate revenues. Return on equity is the net income of the firm divided by directly-invested shareholder equity. This ratio allows analysts to observe how well management uses investments to bring revenues into the firm. The chart below shows 10 years of return on assets and return on equity for Microsoft.
The chart above shows 10 years of return on assets and return on equity for Microsoft. In the bullets below, let's examine the relationship between firm performance and share price performance. A summary of this discussion is found in the table below.
- The first period we will examine is the five year period between 2003 and 2008. During this time period, Microsoft doubled its return on assets and return on equity. This tangibly means that Microsoft became more efficient at transcribing its asset base into net income as well as earning a return for the shareholders of the company. Prudent investors seek to park capital with firms that deliver a return and Microsoft is no exception to this observation in that during this time period, share price increased around 36%.
- Between 2008 and 2010, Microsoft experienced a decrease in firm performance in that both return on assets and return on equity shed roughly a fifth of their values from peak-to-trough. This degradation in firm performance represents a period of time in which Microsoft was no longer able to deliver the same level of performance that it had at its peak in early 2008. This decline in performance was coupled with a decrease in share price of around 14% as investors fled the organization.
- Between the years of 2010 and 2012, Microsoft once again entered a period of growth and expansion in that return on assets and return on equity increased. This period of growth was brief; however investors seized the opportunity to invest in fundamental momentum and added 7% to the share value.
- 2012 was a pivotal year in the history of Microsoft in that firm performance experienced the largest collapse in the past decade. Throughout 2012, return on assets and return on equity have declined by nearly half. This is the largest decline in percentage terms that Microsoft has experienced in the last 10 years and it bears added significance in that shares were able to eke out a 1% gain over the past 12 months. This represents a decoupling between firm and share performance, which ultimately indicates the presence of a shorting opportunity.
As can be seen in the table above, a clear relationship exists between firm performance and stock performance. As the firm betters itself fundamentally, as measured by return on assets and return on equity, the market tends to reward the security by increasing its price. This lockstep relationship makes perfect sense in that the majority of investors tend to allocate capital to firms which grow rather than decline.
It is in light of this historic and logical relationship that I recommend shorting Microsoft or selling existing shares. Firm performance experienced its worst percentage change for the entire decade in 2012. This collapse of firm performance seems to have gone unheeded by the market in that investors still managed to earn a return of 1% (including dividends) in 2012. I believe that this decoupling between firm performance and share price represents an excellent opportunity for the nimble investor.
I have found that the most effective investing frameworks tend to rely on the presence of several different factors which all provide the same recommendation. Fundamentally speaking, Microsoft is an excellent shorting opportunity in that firm performance has collapsed over the past year. In this section of the article, we will examine the statistical properties of Microsoft in order to glean additional insight into this security. Specifically, we will examine what is "normal" by observing price change and standard deviations of change. Standard deviation is a relatively simple statistical concept in that it allows individuals the ability to understand what is normal and denote events which are abnormal. The chart below shows a decade of monthly price changes with two standard deviation bands.
The chart above shows a decade of price change. The green and red lines show what is "normal" in terms of price change. Basically, if the return is between these two boundaries, then we are 95% certain that everything is normal. Microsoft is a noteworthy security in that normalcy defines the company. Since share price has essentially gone nowhere in the past 10 years, investors have been safe purchasing the security any time that it abnormally declines or shorting the security when it abnormally rises. Statistical investors have earned an exorbitant return over the past decade by trading departures from normality. The table below shows the returns that investors who trade against abnormality in Microsoft have earned over the past decade.
This table is generated by showing the percent change in share price which has resulted in Microsoft after price returns have departed from what is normal. The table assumes that the investor would purchase or short any month which is outside of the normal distribution of returns and hold the position until price once again steps out the upper or lower bands. What is truly amazing is that investors who have pursued this strategy have earned a 165% return over the past decade from a security which has essentially gone nowhere. Not only is this excellent return noteworthy, but also the consistency and reliability of this system deserves attention. This systematic method of statistically trading Microsoft has resulted in profitable signals 100% of the time for the past decade. In light of this performance, we can confidently say that the short signal generated at the beginning of 2012 may earn profit for investors in the future.
A final factor which I have relied on in my analysis of Microsoft is technical analysis. Through studying the trends in price, investors can best position themselves to both profit from a fundamental thesis and protect capital through risk management. In the chart and explanation below, I have detailed appropriate participation levels for investors in Microsoft.
Microsoft has entered a period of downward trending prices. This is significant in that it confirms our fundamental and statistical thesis that price should decline in the near future. I believe that investors who agree with this thesis should consider shorting at $26.25. This level represents a point at which shares will have continued the downward momentum established in the middle of 2012. Investors should consider placing a stop-loss at $27.75 to protect against a reversal in trend direction. The most logical place to take profit is near the technical floor of $23.50. The table below shows a breakdown of this recommendation. The trade is favorable in that the investor stands to gain $2.00 for every $1.00 he or she is willing to risk. Probabilistically speaking, if the investor believes that this analysis has even a 50% of being correct, then he or she would benefit from taking the trade.
I believe that Microsoft has strong fundamental, statistical, and technical reasons to experience decreases in share price in the near future. It is my firm opinion that individuals who are short Microsoft over the following months stand to greatly benefit. I do not base this opinion on qualitative factors such as product reviews or peer comparisons but rather on quantitative and actionable data. History reveals truths about the market to those who are willing to listen and I believe that the tape suggests shorting Microsoft. Oh, and by the way, Microsoft decreases in 61.54% of all Februaries, and if investors would have shorted every single February since the company listed in 1987, he or she would have earned a 136% return. Looks like the odds favor the bears in the near future.