How Microsoft Stock highlights an important market debate

<p>The sale in Microsoft (NASDAQ: MSFT) must almost be a huge buying opportunity. Microsoft’s share has fallen 28% since February 19. And that decline seems to make no sense.

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After all, Microsoft has little exposure to the short-term disasters that the US economy will face. Of course, some revenue will be delayed. For example, the adoption of the Azure cloud platform will be stopped. Office 365 sales will pick up and may see pressure in the medium term if the shutdown in the short term becomes a recession in the medium term.

In fact, at the end of February, Microsoft already withdrew its guidance for the Personal Computing segment during the third quarter due to the impact of the coronavirus.

Obviously, Microsoft is not an airline or a restaurant operator. The impact on the result will be relatively modest in the large order. It really does not seem to be enough to suggest that Microsoft is worth 28% less than four weeks ago. With cash in the balance sheet far above liabilities, there is also no risk of bankruptcy.

And apart from coronavirus effects and the resulting guidance for a single segment, there has been zero news during this sale. As a result, this looks like a panic and illogical divestment of one of the world’s best stocks.

But from another angle, the decline in the MSFT share looks much more logical than it may seem.

Microsoft Stock is too cheap … right?

Amazingly, Microsoft has lost over $ 400 billion in market value in less than a month. It is impossible to argue that the corona virus will have any close impact on the present value of Microsoft’s future cash flows – which in theory should correspond to the MSFT share price.

In fact, it is impossible to argue that the effect will even amount to $ 40 billion, a figure that roughly corresponds to Microsoft’s adjusted net profit for the entire fiscal year 2019 (end of June).

It’s the bullshit for Microsoft’s shares on dip: that this sale is unjustified.

But the case is based on the most important assumption: that February 19 when $ 187.28 was the “right” price for Microsoft shares.

Checking back

It is far from guaranteed. At the end, MSFT closed almost 33 times the consensus earnings per share for the year 2020.

At least in relation to the modern age, it is a multiple that is likely to be unparalleled. Mature companies do not get that kind of multiple. The second most valuable company on the market – behind Apple (NASDAQ: AAPL) – has probably never traded at more than 30x profit. Rarely would the multiple come over 20 times.

Go back to mid-2007. A multi-year bull market was about to end. But even then, the market’s most valuable companies looked almost cheap in terms of revenue. Exxon Mobil (NYSE: XOM) was the world’s most valuable company and traded at 12x profit. General Electric (NYSE: GE) was second and traded at 19x. Microsoft was fourth after the French oil giant Total SA (NYSE: TOT) and was valued at only 21x profit.

The question here is not about the quality of Microsoft as a company. There is little doubt. The issue comes down to valuation. At some point, even for one of the world’s best companies, the share price must matter.

MSFT rejects

And even after the downturn, Microsoft shares still have a historically high valuation. The shares are still trading at 22 times next year’s consensus EPS estimate. (That estimate has not shifted in the past month and therefore reflects expectations before the worst effects of coronavirus became apparent.)

Again, relative to the bull market in 2007, it is a fairly high multiple. Against the expected ~ 11% EPS growth, it is not very cheap.

This is not to say that Microsoft shares should be traded at $ 135. Rather, it is to say that, even after the downturn, the basics on their face are not dramatically out of line.

In fact, as steep as the downturn has been, it is not as if the Microsoft stock is at a multi-year low. The stock has only returned to the place where it was traded in October.

As I wrote before MSFT turned south, the stock had a historic run. The stock had a market capitalization of over $ 700 billion and then doubled in 14 months. Even with this withdrawal, Microsoft has still published astonishing returns for a company of its size in recent years. And that in turn suggests that there is at least one chance to run simply went too far.

The market type

This debate reflects it as the whole market. Since February 19, the S&P 500 fell almost 30% and lost almost exactly 1,000 points.

That decline is not solely driven by short-term coronavirus-driven closures. It is not necessarily driven by investor panic either.

Rather, at least to some extent, there is a revaluation of the entire market right now. In other words, the spread of the coronavirus in the United States has been a catalyst for a sale that has taken place for various reasons.

To what extent this is true will determine where the market goes from here. But at least that argument is credible, both for Microsoft stocks and for US stocks as a whole. For both, “cheaper” does not guarantee “cheap”.

Vince Martin has been covering the financial industry for nearly a decade for InvestorPlace.com and other stores. He has no positions in any of the mentioned securities.