Is Microsoft Stock Undervalued?

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Microsoft

With shares of Microsoft (NASDAQ:MSFT) trading around $31, is MSFT an OUTPERFORM, WAIT AND SEE, or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Trends for a Stock’s Movement

Microsoft is engaged in developing, licensing, and supporting a wide range of software products and services. The company also designs and sells hardware, and delivers online advertising to customers. It operates in five segments: Windows & Windows Live Division, Server and Tools, Online Services Division, Microsoft Business Division, and the Entertainment and Devices Division. As a mature company, Microsoft is also offering a stable dividend, which is currently yielding around 2.92 percent annually.

Recently, Microsoft posted disappointing earnings, which some think is a sign that the slump in PC sales has caught up with the company. Microsoft hasn’t been able to successfully plant themselves in mobile computing just yet, and suffered significant charges for unsold Surface tablets. The company missed the mean analyst estimate, as well as the average revenue estimate.  Through its divisions and reorganization, look for Microsoft continue to be able to provide valuable products and services. However, investors may need time to digest the recent disappointing earnings report.

T = Technicals on the Stock Chart are Mixed

Microsoft stock was surging higher over the last several months. However, the stock has gapped much lower after failing to meet expectations for a recent earnings report. Analyzing the price trend and its strength can be done using key simple moving averages.

What are the key moving averages? They are the 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Microsoft is trading between its key averages, which signals neutral price action in the near-term.

MSFT

(Source: Thinkorswim)

Taking a look at the implied volatility (red) and implied volatility skew levels of Microsoft options may help determine if investors are bullish, neutral, or bearish.

Implied Volatility (IV)

30-Day IV Percentile

90-Day IV Percentile

Microsoft Options

22.86%

0%

0%

What does this mean? This means that investors or traders are buying a very minimal amount of call and put options contracts, compared to the last 30 and 90 trading days.

Put IV Skew

Call IV Skew

August Options

Steep

Average

September Options

Steep

Average

As of today, there is average demand from call buyers or sellers, and high demand by put buyers or low demand by put sellers, all neutral to bearish over the next two months. To summarize, investors are buying a very minimal amount of call and put option contracts, and are leaning neutral to bearish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates, and what that means for Microsoft’s stock.

E = Earnings Are Mixed Quarter-Over-Quarter

Rising stock prices are often strongly correlated with rising earnings and revenue growth rates. The last four quarterly earnings announcement reactions can also help gauge investor sentiment on Microsoft’s stock. What do the last four quarterly earnings and revenue growth (Y-O-Y) figures for Microsoft look like, and more importantly, how did the markets like these numbers?

2013 Q2

2013 Q1

2012 Q4

2012 Q3

Earnings Growth (Y-O-Y)

-11.94%

20.00%

-2.56%

-22.06%

Revenue Growth (Y-O-Y)

10.17%

17.71%

2.78%

-7.83%

Earnings Reaction

-10.96%*

3.36%

0.90%

-2.91%

Microsoft has seen decreasing earnings and increasing revenue figures for most of the last four quarters. From these numbers, it seems the markets have not been too happy with Microsoft’s recent earnings announcements.

* As of this writing

P = Excellent Relative Performance Versus Peers and Sector

How has Microsoft stock done relative to its peers, Apple (NASDAQ:AAPL), Oracle (NASDAQ:ORCL), Google (NASDAQ:GOOG), and the overall sector?

Microsoft

Apple

Oracle

Google

Sector

Year-to-Date Return

18.03%

-19.89%

-5.19%

27.25%

11.47%

Microsoft has been a relative performance leader, year-to-date.

Conclusion

Microsoft is a technology bellwether that provides valuable software products and services to consumers and companies worldwide. A recent reorganization, as well as a disappointing earnings report, really has investors thinking about the company’s future. The stock was on a strong run over the last several months, but has now gapped down significantly. Over most of the last four quarters, investors in the company have not been too happy, since earnings and revenue figures have moved in opposite directions. Relative to its peers and sector, Microsoft has been a year-to-date performance leader. WAIT AND SEE what Microsoft does this quarter.

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