Microsoft earnings set for virus boost but overvalued stock faces downside risks – Stock Market News


Raffi Boyadjian, XM Investment Research Desk

US software giant, Microsoft Corporation, will announce its earnings results for the June quarter on Wednesday after the market close. Like most of its tech peers, Microsoft is expected to report year-on-year growth in revenue, bucking the depressing trend of the broader market where top lines have been negatively impacted by the coronavirus. But with the recent equities rally pushing the Company’s stock price well into the overvalued zone, will the earnings guidance impress investors who have become somewhat more cautious of late?

Lockdowns have been good for Microsoft’s core business

It is no secret that companies with a strong online presence have not only withstood the worst of Covid-19’s effects but have seen their businesses boom from the stay-at-home policy brought on by the pandemic. In Microsoft’s case, the gain has been two-fold. Its suite of Office software has been a vital platform for connecting professionals around the world that have been forced to work from home, many of whom have yet to return to their workplaces.

But it’s not only from businesses that the Company has seen a surge in demand for its products and services. Schools and universities have also resorted to doing things remotely, with Microsoft Teams becoming an essential tool for online teaching.

All this has been a major boost for Microsoft’s cloud business, Azure, which has seen usage soar since March when Europe and America implemented lockdowns. The cloud computing unit had already been benefiting from the revolution in the cloud industry, despite facing stiff competition from the likes of Amazon.com’s Amazon Web Service and Alphabet’s Google Cloud Platform.

Earnings likely lifted by stay-at-home trend

The unforeseen need for remote working and schooling couldn’t have come at a better time for Microsoft, which in recent years had made a big push into cloud services and shifted to a subscription-based model for its Office and Windows software. Its fourth quarter earnings should reflect this booming trend.

Revenue is expected to have hit $36.64 billion in the three months to June, representing a year-on-year rise of 8.7%. Full-year revenue is forecast to have reached $141.67 billion, up 12.6% from fiscal year 2019. Earnings per share (EPS) is estimated to have been more mixed, however, as the virus-induced economic slump may have put a strain on Q4 profit margins. EPS is forecast to have declined by 1.6% to $1.35, though full year EPS is expected at $5.66, up 19.1% y/y according to I/B/E/S Estimates by Refinitiv.

Can the stock go any higher?

Having come under selling pressure recently, Microsoft stock should enjoy a rebound if the earnings beat the expectations. Strong results could spur the share price to re-challenge the recent all-time high of $216.38, with the next target above this top likely to come from the 161.8% Fibonacci extension of the February-March downtrend at $226.66.

However, an earnings miss, or more specifically, disappointing guidance about future revenue growth could extend the recent declines towards the 50-day moving average (MA) at $193.97. Steeper losses could push the price as low as the 61.8% Fibonacci of $168.48, which lies just above the 200-day MA.

With growing talk of a tech bubble, the sector is most at risk from a sharp negative correction, especially if predictions that the US economic recovery is faltering materialize. As impressive as Microsoft’s business performance has been during the pandemic, it would not be immune to bearish forces. If anything, the Company is more vulnerable given its existing high valuation.

P/E ratio is flashing red

Microsoft’s trailing 12-month price/earnings (P/E) ratio currently stands at 37.2, marginally below the average of the tech sector (38.7) but much higher than that of the S&P 500 Composite (23.36). More concerning, however, is that its forward 12-month P/E is very elevated at 33.6, well above the 13.6 average of the wider tech sector. This puts Microsoft stock in prime position for a sell off should tech stocks come crashing down.

But that’s a worry for another day as analysts are maintaining their mean ‘buy’ recommendation for the Company’s shares with a median price target of $223.00. The bullish forecasts could come under scrutiny if Microsoft’s guidance for the next quarter doesn’t live up to the earnings growth implied by the P/E valuation. However, with the Company now expanding its cloud business into the health sector, there should be plenty to keep investors excited about.