Approach Microsoft Stock Cautiously as it Goes Into Earnings

Will Healy

Microsoft (NASDAQ:MSFT) stock reports earnings Wednesday after the market close. The company usually beats estimates, so the actual numbers may have little effect on Microsoft stock. However, both the stock price and the valuation continue to approach elevated levels.

Is a Death Cross Brewing in Microsoft Stock?

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Moreover, other factors could cause a near-term pullback. Although MSFT stock looks solid for the long term, investors should probably not buy this equity going into earnings.

Expect Higher Earnings and Revenues

For its fiscal third quarter, analysts forecast consensus earnings of $1 per share. The company earned 95 cents per share in the same quarter last year. They also expect revenues of $29.84 billion. If this prediction proves correct, it will represent an 11.3% increase from year-ago levels, when the Redmond, Washington-based software giant brought in $26.82 billion.

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Investors should also note that Microsoft beat earnings in each of the last four quarters. MSFT may have only beaten estimates by one penny per share in the previous report. Still, most traders will probably expect that streak to continue in the upcoming release.

Microsoft Stock Remains Solid for the Long Term

In many respects, things have never looked better for Microsoft stock. MSFT trades near all-time highs. The tech giant once depended on its operating system. Today it has turned itself around and boosted its profits by becoming one of the premier cloud computing companies. Cloud profits explain why Wall Street forecasts average profit increases of 14.5% per year for the next five years.

Today, only Amazon (NASDAQ:AMZN) surpasses Microsoft in cloud-based revenues. It has also become a contender with Amazon for JEDI, a $10 billion project that would accelerate the Pentagon’s adoption of cloud platforms.

The company also continues to maintain one of the most solid balance sheets in corporate America. Its cash hoard of $127.66 billion may lag that of Apple (NASDAQ:AAPL), but it remains the only company other than Johnson & Johnson (NYSE:JNJ) to hold a AAA credit rating. That alone means that long-term investors should probably stay in MSFT and collect the $1.84 per share in annual dividends.

Consider Exercising Caution at These Levels

Still, as it approaches the $1 trillion market cap for the first time, many wonder whether prospective buyers should get in now. The price-to-earnings (P/E) ratio has remained elevated since soon after Satya Nadella took over as CEO in 2014. Its current 29 trailing P/E ratio compares well to the average multiple of 33.3 over the last five years.

However, other ratios point to overvaluation in Microsoft stock. The stock has risen more than 30% from its December lows. Moreover, MSFT trades at more than eight times sales, and its price-to-book ratio now exceeds 10. MSFT faces other possible issues. As my colleague Will Ashworth points out, allegations of sexual harassment within the company could lead to traders questioning the equity’s multiple. Moreover, the odds slightly favor Amazon on the JEDI contract.

To be sure, any significant drop in Microsoft stock would likely create a buying opportunity. However, new buyers should probably wait for that time before opening a position.

Final Thoughts on MSFT Stock

Although Microsoft stock remains a solid, long-term pick, near-term factors probably mean that new investors should wait to buy. Yes, analysts expect earnings and revenue to rise on a year-over-year basis. Also, if the recent history of MSFT stock serves as an indication, it will likely beat those earnings.

However, the P/E ratio has become elevated. Moreover, issues related to “me too” remain a cause for concern. With the stock up more than 30% in the last four months alone, any bad news could lead to a short-term drop in the equity.

None of this news will make Microsoft stock a sell except to very-short-term traders. However, after the recent move higher, new buyers should probably hold off on MSFT going into earnings.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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