Buying a stock near the highs is frequently a poor investing decision. It not only diminishes the margin of safety but also reduces the potential return. With a lower margin of safety, an investor may unnecessarily invite losses and face the troublesome risk that the investment may not perform according to his expectations. Microsoft (NASDAQ: MSFT) is one such investment at all-time highs.
I first gave the stock a buy recommendation on August 31, 2016, with a target price of $65 in 9-12 months. Microsoft surpassed my expectations and hit the target in just 4 months. This article will attempt to prove why MSFT is a ‘hold’ at this time and discuss the level which an investor can utilize to create long positions. To serve this purpose, I will use a technical price chart and fundamental information taken from various sources.
The monthly MSFT price chart below clearly tells us that the stock is in a strong uptrend for the last four years and investors who entered near the lower range have been rewarded handsomely. This is as easy as it gets. The benefit of using the monthly price chart is that it diminishes the noise component and gives an accurate picture of the stock performance. As a bonus, the trajectory indicated by a monthly price chart is often sustainable in the long-term. Microsoft’s trajectory has remained firmly upwards which tells me that the lower range should continue to attract investors.
Another reason why I refrain from recommending a buy at this point is because the stock is touching overbought territory on the monthly charts. This is quite a rare phenomenon as can be seen in the 10-year chart above. The latest monthly RSI reading is at 69.1149. 70 is the overbought mark.
The lower end of the multi-year range is currently at $53, at an 18.3 percent discount from the current price. But, this clearly does not mean that the stock will immediately decline to this level; not unless the broader market topples. Instead, it can enter into a consolidation phase just like it did the last two times (marked as green rectangles in the chart) and remain flat for the next 8-10 months. During this sideways action, the company’s fundamentals will play catch-up to the market price and make the stock less expensive to look at.
What If The Stock Breaks Out On The Upside?
Many bulls watching this trend are also hoping for the stock to breakout on the upside. They base their belief on the conservative forward PE of 19.8 and the analysts’ expectations of rapidly surging EPS in the years ahead. But, the analysts cannot boast of a good track record of predicting MSFT’s earnings per share. This fact is highlighted by the historical earnings per share and the range of past estimates as well as the wide divergences in the estimates of future EPS.
For FY 2018, 11 analysts are estimating a range of $2.36-$3.83 in earnings per share.
This makes the task complicated for an investor since he is unable to ascertain if the future growth has already been baked into the price or not. With such uncertainty staring at him, it is always helpful to look at the valuation metrics. I have presented below the 10-year MSFT ratios, all of which (except the price-to-owner-earnings) tell the same thing: Microsoft is not a buy at this time. Currently, MSFT’s valuation metrics are vastly distant from their mean and median values. This enhances the possibility that the stock could provide below-average to no-returns in the next 2-3 quarters.
I exhort this simple mantra I use for my investing decisions: The best investing opportunities do not come from chasing, but rather from waiting. Investors do not have to rush to buy MSFT now but wait for more conservative levels like $53-$55. The fundamentals are clearly stretched and limit the scope of higher future returns. Sitting patiently now for lower levels will not only improve the margin of safety in the investment but also greatly reduce the probability that the stock enters into a tiring sideways range after an investment has been made.
If an investor wants to invest solely for the dividend, there are plenty of other opportunities in the market like AT&T (NYSE: T), Verizon (NYSE: VZ), General Motors (NYSE: GM), Qualcomm (NASDAQ: QCOM), etc offering significantly higher dividend yields.
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Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.
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