We urged investors in our previous update on Microsoft Corporation (NASDAQ: MSFT) stocks should be cautious adding to these levels, despite its strong summer rally to form its August highs.
However, the main bugbear with MSFT is no doubt its valuation. Despite falling from its November 2021 highs (down 32%), its valuation was unattractive at its August highs amid stronger macro headwinds. Additionally, Microsoft’s PC business could be further impacted by weak end demand from PC OEMs, compounded by tough comps and record inflation. The business environment has also become more cautious, with the sales cycle becoming more deliberate and stretching longer. Therefore, MSFT’s valuation multiples need to account for these headwinds accordingly to justify execution risks at least in the coming quarters.
Notably, MSFT returned to its June lows and retested its critical support zone. We have yet to discern a bullish reversal that could help further curb downside volatility. However, the opportunity for a reversal from here is still possible given the pace of the recent pullback.
We also infer that its valuation is more attractive now, which could support a bottoming process based on its June lows.
Therefore, we believe it is appropriate to revise our Hold to Buy rating and encourage investors to start layering.
MSFT Stock Is Fair, But Not Cheap
MSFT jumped to NTM’s EBITDA multiples that topped its 10-year average in November 2021. It notably settled in the area of two standard deviations above its average. As a result, one could even argue that MSFT was well overvalued at these levels. Moreover, these levels were so frothy that even CEO Satya Nadella managed to sell more than $285 million of his holdings in November 2021, while “long-term” investors held on. If Nadella was a stock picker, he succeeded with his timing to liquidate his huge inventory of MSFT stocks.
However, last year’s setbacks have pushed MSFT back closer to its 10-year average of 13.7x, but still not there. Nonetheless, we believe this area looks robust, as it has supported MSFT against further decline since 2018. Therefore, we postulate that the market has likely repriced MSFT, given the robustness of its cloud business.
Microsoft can withstand recession risks
We believe there is no doubt that no business can be immune to an impending recession caused by the Fed’s rapid rate hikes. Even Microsoft CCO Judson Althoff pointed this out at a recent conference in September. He added:
The economic environment is arguably the most uncertain we have seen in decades. [But], if you think about it on a macro level, customers are still trying to solve the same problems they were trying to solve before this economic crisis hit. And then, on top of that, cybercrime is on the rise. The bad guys don’t slow down. And so threats come from everywhere, even nation states, and preparing your business to be able to tackle those things is a very difficult thing. And so all of this happens on top of having to find a way to solve it while spending less money. (Goldman Sachs Communacopia + Technology Conference 2022)
Therefore, we think it’s pretty clear that the company remains confident in its secular opportunities throughout the cycle, given Microsoft’s scale, technology leadership, and integration capabilities. As a result, investors shouldn’t underestimate Microsoft’s competitive fluke in an economic downturn, given its age-old drivers.
As discussed above, we believe the (very bullish) consensus estimates are credible, as the Street forecasts a further acceleration in Microsoft’s revenue growth and Adjusted EBIT from 2023. Therefore, Microsoft shouldn’t suffer a cyclical hangover from the impending recession that could hurt economically sensitive industries more significantly.
Nevertheless, the strong digestion of its PC business should continue to put additional pressure on its performance in the short term. However, Microsoft’s robust cloud business should help mitigate the weakness, although investors should expect a slowdown in the coming quarters.
We assessed that the market likely anticipated these challenges, coupled with harder-to-manage comps, as it beat MSFT over the past year. Moreover, the market understood that Microsoft could not maintain its maximum valuations because its growth could slow.
Is the MSFT stock a buy, sell or hold?
MSFT remains in a medium-term downtrend, with its recent August highs forming its near-term resistance zone. However, investors should note that MSFT’s long-term uptrend bias remains intact. Therefore, investors should assess whether they expect its June lows to hold solidly, despite the recent significant pullback.
Our assessment indicates that the fall from its August highs is emblematic of a rapid plunge to force capitulation over the past five to six weeks. Therefore, we expect to find robust buying support at current levels which may help prevent further declines in selling. However, we must warn that we have yet to see a bullish reversal. Therefore, if you decide to add an exhibit, it might be premature.
More conservative investors may consider waiting for a validated bullish reversal over the next few weeks or waiting for a sustained bottoming process. However, we are confident that its valuation has improved adequately in fair value areas for investors to start layering.
As such, we are revising our rating on MSFT shares of Hold to Buy.