The upcoming week will be packed with major US tech companies’ earnings releases, which are expected to garner significant attention as the tech clan is going to face a tough annual comparison amid increasing macroeconomic headwinds. The software behemoth Microsoft is the first to unveil its Q3 financial performance on Tuesday, October 25, after Wall Street’s closing bell. The third most valuable publicly traded company in the world is expected to record decelerating but solid revenue and earnings figures, despite its share price depreciation of almost 30% so far in the year. Where should investors focus?

Tough year for tech stocks

In 2022, the Fed’s ongoing rate hike cycle to counter inflation has triggered a broader sell-off in tech stocks. It is common knowledge that rising interest rates directly reduce the value of companies’ future cash flows, which is an extremely negative development for the tech sector as its performance heavily relies on growth prospects. Furthermore, higher interest rates could discourage borrowing, reducing firms’ disposable funds for investment and development spending.

Apart from that, interest rate differentials between the US and overseas economies are anticipated to widen even further as the US economy remains strong and inflation shows no signs of subsiding, increasing the greenback’s outperformance against other currencies. This trend would likely continue to adversely affect US firms’ revenue from abroad as their income in foreign currencies would be continuously devaluing.

Idiosyncratic risks

Additionally, Microsoft has been suffering from the Russian invasion of Ukraine and its imminent consequences on the global economy. Specifically, apart from the loss of the Russian market share as Microsoft suspended new sales in Russia, the war has exacerbated inflationary pressures, increasing prices of raw materials that are essential for Microsoft’s computing business. Moreover, the inflation-squeezed consumers are starting to spend less on leisure-tech gadgets, with Microsoft expecting to record a decline in both Xbox and PC windows sales.

The anticipation of a general slowdown in its growth in the upcoming months was reinforced by the management’s statement on Monday that the firm will trim its working force by almost 1%, announcing 1,000 layoffs and a pause on future hiring.

Diverse business boosts performance

During the last few years, Microsoft has diversified its business model, launching operations in multiple sectors other than the personal computing arm. The tech giant currently provides an array of vital services and products to businesses, such as cloud computing, software applications and data centres, which are expected to remain resilient as the corporate world has adapted to a digital framework since the Covid-19 outbreak.

Poised for solid fundamentals

Microsoft is set to post a strong third quarter financial performance amid a constantly deteriorating macro environment. The software giant is expected to report revenue of $49.78 billion, according to consensus estimates by Refinitiv IBES, which would represent a year-on-year growth of 9.9%. Earnings per share (EPS) are estimated to jump to $2.31, producing a minor increase of 1.8% compared to the same quarter a year ago.

Even though the upcoming financial results are anticipated to reflect a slowdown in core performance metrics, it should be noted that Microsoft's efforts to diversify its income streams have indeed materialized, helping the company to remain resilient in these unfavorable market conditions.

Valuation has corrected but still a little ‘pricey’

Market participants appear confident that Microsoft can achieve its growth targets as it has been trading with a premium against its major tech competitors. The firm is currently valued with a trailing 12-month price to earnings (P/E) ratio of 25.2.

Furthermore, its forward 12-month P/E ratio is currently at 22.5, with all its major competitors and benchmarks reporting a significantly lower figure. Therefore, investors seem to be pricing in massive growth potential for the firm, while it could also be argued that the stock is currently overpriced.

Will the stock rebound?

Microsoft’s share price has been beaten down more than 30% this year amid a broader stock market decline. Therefore, investors will be closely eyeing the firm’s Q3 earnings release for signs of persistent fundamental strength, which could halt or eventually reverse the downtrend.

To the upside, a positive earnings surprise could propel the price towards the recent peak of $250. Successfully breaching this region, the price might then test the $268 barrier.

Alternatively, should financial figures disappoint, the bears might aim for $228. A violation of the latter could open the door for the 2022 low of $219