There’s no shortage of “buy the dip” candidates in tech right now. Microsoft (NASDAQ:MSFT) looks like one of the more attractive at the moment. Despite another blowout quarter Microsoft stock has pulled back.
With a 2%+ decline on Tuesday, MSFT stock has dropped about 13% from early October highs which is a far cry from what the fiscal Q4 report late last month would have indicated.
That decline doesn’t sound that bad in the context of the current market. The ‘FANG stocks‘ all are in bear market territory, down 20%+. Apple (NASDAQ:AAPL) has declined 23%. The news elsewhere in tech (see Nvidia (NASDAQ:NVDA) and Activision Blizzard (NASDAQ:ATVI), among others) has been even worse.
Still, 13% is too big a drop, even though I did think Microsoft had run too far at those levels. Between raised expectations for fiscal 2019 and a lower stock price, Microsoft has moved from pricing in potentially too much growth to pricing in too little.
The turnaround here admittedly has mostly run its course, and more aggressive investors should look to bigger sell-offs for major upside. But Microsoft’s decline has moved it back to where investors can expect steady double-digit returns going forward, and perhaps more if Microsoft’s growth drivers continue to outperform.
MSFT Stock Fundamentals Have Improved
The simplest argument for buying the dip in Microsoft stock is that between the sell-off and Q4 earnings, the fundamentals have changed noticeably.
At $115 heading into the Q4 report, analysts were expecting about $4.91 in EPS from Microsoft in FY19. Backing out cash, that suggested about a 22x forward P/E for MSFT stock. MSFT now trades at $101 and consensus has moved modestly over $5.
Suddenly, MSFT stock is valued at roughly 18x forward earnings (and maybe a bit higher), again backing out cash.
For a stock like MSFT, that’s actually a reasonably substantial compression. This isn’t a company likely to grow 20%+ a year consistently at this point. Nor is it a company likely to see earnings decline. That stability means the argument around Microsoft stock largely comes down to minor disputes over valuation.
But the change hasn’t been minor. 18x generally prices in mid-single-digit EPS growth; 22x probably moves at least toward high-single-digit and maybe low double-digit increases. And so a month ago, there was a case that even optimistic scenarios were priced in, or close. That’s a much less compelling argument at this point.
Obviously, analyst estimates aren’t always right; the sell-off could be caused in part by lower expectations. But the fundamental case makes sense qualitatively as well. None of the fears driving the recent tech weakness should impact Microsoft all that much.
A recession would hurt sales to some extent, but Microsoft’s huge user base provides quite a bit of protection from economic cycles. The cloud shift is going to continue regardless, and Azure’s growth continues to be torrid, with a 78% increase in revenue in Q4.
Tariff impacts seem minimal. Interest rates are mostly immaterial given net cash. And it’s not as if MSFT was some super-priced high-flyer to begin with.
Investors can buy what looks like the same growth for about 16-17% less (backing out cash from the share price). That’s probably a good deal.
Should You Pick Microsoft Stock?
The more interesting question is not whether MSFT stock is a buy but whether it’s the best buy. Again, there are plenty of tech stocks out there that are cheaper than they were in early October.
But most of those declines have been driven by legitimate, company-specific risks, particularly in large caps. NVDA has been nearly halved, but there were real concerns highlighted in the company’s Q3 report last week.
Facebook (NASDAQ:FB) looks like a mess. Amazon.com (NASDAQ:AMZN) was trading at astronomical valuations. Apple is facing potentially declining smartphone demand. Alphabet (NASDAQ:GOOG,GOOGL) has concerns in both the core advertising business and its Other Bets.
To be certain, there are higher potential rewards in those plays. Facebook could right its ship. Amazon.com still is going to extend its dominance. GOOGL stock looks cheap. NVDA could recover from its crypto woes. Growth stocks like Square (NYSE:SQ) and Workday (NASDAQ:WDAY) could resume their upward trends.
Still, in each of those cases, there are specific reasons why the stock has pulled back. That’s not necessarily true for Microsoft stock. The company continues to perform quite well, and its growth drivers all seem to be intact. This looks far more like an instance of the market throwing out the proverbial baby with the bathwater.
The underlying strength here likely is why Microsoft stock hasn’t sold off as much as so many other well-known tech plays. But it’s still sold off. And nearing $100, that sell-off simply has gone too far.
As of this writing, Vince Martin has no positions in any securities mentioned.