Tech stocks got smacked upside the head last week. Microsoft (NASDAQ:MSFT) lost 6.4% over the past five days through Sep. 4. The correction looks as if it could carry on for some time. If you own MSFT stock or are considering buying it, patience is required.
Here’s why.
MSFT Stock Has Come a Long Way
On a year-to-date basis, Microsoft’s stock has a total return of 31.5%. Over the past year, its total return is 55.3%, and over five years, it’s got a total return of 386%, outperforming the software sector, and almost three times better than the U.S. markets as a whole.
If you’re a long-time investor, I don’t think you should complain about those numbers. They’re rock-solid.
The last time I wrote about Microsoft was in late May. At the time, it was trading around $183. I previously (April 2020) suggested that even though the company would have a couple of shaky quarters, MSFT stock would hit $200 in 2020.
In my most recent column, I said the following:
“Wedbush Securities analysts Daniel Ives and Strecker Backe suggested in late April that the cloud business was worth as much as a trillion dollars. This meant that the markets were valuing the rest of its business at $360 billion. That includes Windows, Office 365, Microsoft Teams, Surface, Xbox, etc.,” I wrote on May 29.
“I find it hard to believe those pieces combined are worth just one-third of its cloud business. Either the analysts have gotten the cloud estimate wrong, or the sum of its parts is worth a heck of a lot more than $1.36 trillion.”
To me, 30 times forward earnings seemed like growth at a reasonable price. For this reason, I believed $200 was just around the corner. It hit $200 in late June and has remained above this mark ever since, testing this support on three occasions, but always rising higher.
Despite the correction in the past week, it remains $11 above $200 and trades close to 33 times forward earnings.
As my InvestorPlace colleague Mark Hake stated in late August, Microsoft’s stock should be one of the next companies to hit a market value of $2 trillion in the next 12 months. That works out to $264.62 a share.
Mark’s argument rests on the company’s strong free cash flow generation. In the 12 months ended June 30, it was $45.2 billion, 18.2% higher than a year earlier. Possibly even more impressive, Microsoft converted every dollar of income into four dollars of free cash flow.
That’s a top-drawer performance for any company, including one of the world’s best tech companies.
All that being said, I do think patience is required at this point.
The Market as a Whole Looks Ready to Correct 10% to 15%
Yardeni Research founder and president, Ed Yardeni, appeared on CNBC on Sep. 4. Yardeni, a long-time bull, believes a 10% to 15% market correction at this point could be a good thing for investors.
“The market has had a huge move since March 23. The Nasdaq is up something like 70%. That’s a melt-up. It’s not as big as what we had in 1999 when we had over 200%. But I wouldn’t want to see a repeat of that. So, I’m actually somewhat comforted by the market taking a break here,” Yardeni told CNBC’s “Trading Nation” on Friday. “It’s a healthy development.”
Right now, as we speak, investors are taking profits on their mega-capitalization growth stocks. That includes Microsoft. If any stocks needed correcting at this point, it’s the five largest tech stocks in the S&P 500 (Microsoft is one of the five), which accounts for 25% of the index’s market cap.
However, while Yardeni feels the index will correct 10% to 15%, he feels it’s going to happen in a matter of days. Ultimately, he sees the index finishing the year at 3,500, up 2% over the final four months of the year.
Yardeni’s not the only one who thinks there will be a significant correction.
Former Pimco boss, Mohamed El-Erian, who’s now the chief economic advisor for Allianz (OTCMKTS:ALIZY), believes a 10% correction is in the works.
“We could have another 10% fall, easily … if people start thinking fundamentals,” El-Erian told CNBC. “If the mindset changes from technicals to fundamentals then this market has further to go, but it remains to be seen whether it will change.
The list of investment wonks sounding the alarms is getting longer by the day. With MSFT stock 7% away from $200, I can easily see MSFT dropping below $200 in the next week or two before resuming its climb higher.
As Mark Hake stated, here comes $264.62 over the next year. I believe you’ll be able to buy some shares below $200. At $195, you’re talking about a 35% return.
That’s about average for Microsoft in recent years.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
