Why Microsoft Is Unlikely To Continue Outperforming

| About: Microsoft Corporation (MSFT)

Year-to-date Microsoft outperformed the S&P 500, but will that outperformance continue? The outperformance of Microsoft Corp. (NASDAQ:MSFT) is partly attributable to outstanding first quarter results that beat the street's earnings per share estimate by 6%. Since then, analysts have lowered their estimates for second quarter earnings. Is it likely that Microsoft will have a repeat performance in the second quarter?

History suggests that is unlikely. Over the past four quarters, Microsoft beat earnings by more than 2% twice. Further, Microsoft is overvalued relative to its recent trading history, the S&P 500, and its 5-year averages. Consequently, it would take a huge positive earnings surprise to continue to send shares higher.

Over the last three years and one year, Microsoft underperformed the S&P 500. Also, over longer periods, Microsoft underperformed the industry. The long-term growth forecast for Microsoft is below the peer average and the majority of analysts rate shares a hold. Investors should use Microsoft's recent strength to sell some of their shares.

Business Description

Microsoft Corporation is engaged in developing, licensing and supporting a range of software products and services. The Company also designs and sells hardware and delivers online advertising to the customers. It operates in five segments: Windows & Windows Live Division, Server and Tools, Online Services Division, Microsoft Business Division, and Entertainment and Devices Division. The Company's products include operating systems for personal computers (PCs), servers, phones, and other intelligent devices; server applications for distributed computing environments; productivity applications; business solution applications; desktop and server management tools. In July 2012, Comcast Corp. acquired the Company's 50% stake in MSNBC.com. In October 2012, it acquired PhoneFactor Inc. On July 18, 2012, it acquired Yammer, Inc. Effective March 19, 2013, it acquired Netbreeze GmbH.

Key Information
Price (6/5/2013) 34.78
Market Cap 291.5B
Avg Daily Vol 49.8M
Dividend Yield 2.7%
Trailing PE 18.0
Forward PE 11.6
LTG Forecast 8.7%
ROE 22.6
1-Yr Return 22.0%

Peer Analysis

At this point, Microsoft is a mature company, which can be seen by its high dividend yield and low long-term growth forecast. In fact, of its peers in this analysis, Microsoft has the slowest long-term growth forecast. But, Microsoft does still have a wide moat (little competition) and a high net profit margin.

  Dividend Yield LTG Forecast Net Margin
Microsoft 2.7% 8.7% 29.6%
Oracle 0.7% 10.7% 28.0%
Adobe 0% 10.5% 6.5%
Intuit 1.2% 12.9% 37.7%
Symantec 2.8% 9.6% 10.8%
Red Hat 0% 16.1% -8.0%

Earnings and Price Target

Over the past 4 quarters, the company has reported 2 positive (>2%), 1 negative (<2%), and 1 in-line (within 2%) surprises. The average surprise for this time period has been 2.7%. Most recently on 4/18/13, the company reported quarterly earnings of 0.72 per share, a positive surprise of 6.0% above the consensus of 0.68.

Microsoft's current quarter consensus estimate has decreased over the past 90 days from 0.79 to 0.75, a loss of -5.0%. Consensus estimates for the Software Industry have moved an average -13% during the same time period.

12-Month Price Target
Mean 34.10
High 42.00
Low 27.00
Target vs. Current -2.0%
# of Analysts 32

Microsoft is currently trading near its 12-month price target. That suggests shares of the firm may have little upside remaining.

Analyst Recommendations & Valuations

Distribution of Analyst Recommendations
Strong Buy 7
Buy 8
Hold 21
Reduce 2
Sell 0

Analysts ratings should not be used in isolation, but combined with other evidence they can be a useful tool. Currently, the majority of analysts rate Microsoft a hold and few rate the stock a strong buy. That suggest that shares of Microsoft may have little remaining upside.

  MSFT [TTM] S&P 500 MSFT 5-Year Avg
Price/Earnings 18.0 16.9 12.6
Price/Book 3.8 2.4 4.5
Price/Sales 3.9 1.5 3.5
Price/Cash Flow 9.6 10.1 8.2
Dividend Yield % 2.6 2.2 2.4

Relative to its recent trading history, Microsoft is overvalued. Compared with the S&P 500, Microsoft is overvalued. The twelve trailing months valuations are above their 5-year average, expect the price/book ratio and dividend yield. That suggests Microsoft is likely to underperform in the coming quarters.

Considering the growth forecast, analysts recommendations, the valuations, and low probability of a huge positive second quarter earnings surprise, it is unlikely that Microsoft will continue to outperform. The recent outperformance was mostly attributable to the first quarter earnings surprise, a strong market for equities, and the Fed increasing the size of its asset purchase program.

US M2 Money Supply Growth Chart

US M2 Money Supply Growth data by YCharts

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.