Microsoft: A Sub-Optimal Investment Choice

Mar.11.11 | About: Microsoft Corporation (MSFT)

We previously rolled out an analysis of Dow 30 stocks with a strongly positive outlook for Caterpillar (NYSE:CAT). The second stock to be sliced and diced by our models is Microsoft (NASDAQ:MSFT). In contrast to CAT, this time we are rather skeptical regarding the risk/return potential of the stock over the next six to 12 months.

To make a long story short, our approach is based on quantitative modeling of the business cycle impact on the price of various financial assets. We start by looking at the U.S. monthly GDP model to get an idea of where we are in the business cycle and what lies ahead of us.

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A recent update suggests that we have passed the peak and that growth should slow going forward. By the end of summer, GDP growth is expected to start to perk up again. Since the stock market leads the economy by five or six months, it seems that now is a perfect time to position oneself for the next upswing.

Getting the timing right is only the first part of the puzzle. We still need to understand how particular stocks may react to the upcoming economic swing. There are many ways to answer this question, all with their advantages and drawbacks. We favor quantitative analysis over other methods, as it requires just one (albeit strong) assumption: History repeats itself. As soon as this assumption is made, we can let statistical models do the rest of work.

Using 20 years of data and simulating possible outcomes we get the following results:

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Clearly, MSFT should benefit from better economic prospects, as is reflected in the steadily increasing average expected price. Returns might reach 30% by the end of the year, which is attractive by any standards. However, this return comes at the price of a possible 10% drop in the worst-case scenario. In our view, this is a rather high price to pay, given other available options (e.g. CAT) that have much more favorable upside/downside profiles.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.