Reliable Microsoft Stock May See Temporary Volatility

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On Nov. 26, Microsoft (NASDAQ:MSFT),which is one of the hottest stocks on Wall Street, reached its 52-week high equity price of $152.42.

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In 2019, MSFT stock is up about 50%. Microsoft stock has robust fundamentals, which I expect to continue for many quarters to come. However, there might be some profit taking in Microsoft shares in the short run. Long term, investors may regard any dip as opportunity to buy into the equity.

Investors Cheered Microsoft’s Q1 Results

On Oct. 23, When Microsoft released its FY20 Q1 earnings on Oct. 23, investors cheered the results.

The tech giant’s revenue growth increased sequentially in September 2019 to 14% and reached $33.1 billion.  Diluted earnings per share was $1.38 and increased 21% Operating income was $12.7 billion and increased 27%.

Executive vice president and chief financial officer Amy Hood highlighted that “[i]t was a strong start to the fiscal year with … commercial cloud generating $11.6 billion in revenue for the quarter, up 36% year over year.”

Investors noted the impressive metrics in three segments:

  • Revenue in Productivity and Business Processes was $11.1 billion and increased 13%;
  • Revenue in Intelligent Cloud was $10.8 billion and increased 27%;
  • Revenue in More Personal Computing was $11.1 billion and increased 4%.

The Street was also pleased that LinkedIn revenue increased 25%. The platform now has has over 600 million total users and surpassed 260 million monthly active users (MAUs).

During the quarter, Microsoft spent $7.9 billion on dividends and share repurchases, an increase of 28% YoY. As a primarily subscription-based business, Microsoft has stable cash flow, another positive factor to consider for dividend investors.

Microsoft’s Cloud Operations Are Growing

Q1 results show that Microsoft is rapidly gaining market share in cloud services, one of the most important growth industries of the coming decade. Stifel Nicolaus analyst Brad Reback has recently highlighted the growth potential of the cloud segment and increased its target price on MSFT stock to $160.

The group’s cloud business, known as commercial cloud, includes everything from Azure to Office 365 enterprise subscriptions to Dynamics 365 to LinkedIn services.

In other words, the segment continues to incorporate applications that businesses which store data on Microsoft cloud also find valuable, including those driven by artificial intelligence data analytics.

Currently Amazon’s (NASDAQ:AMZN) AWS is the leader in the cloud, followed by Microsoft’s Azure. Over the past few years, the revenue and operating profits of both companies have grown extremely quickly. And the mouth-watering operating margins have also attracted intense competition from Alphabet’s  (NASDAQ:GOOG, NASDAQ:GOOGL) Google Cloud and Alibaba’s (NYSE:BABA) cloud operations.

Now Microsoft and Amazon are going against each other in a potential lawsuit. On Oct. 28, MSFT stock jumped, following the headlines that Azure had been awarded a lucrative Pentagon contract. However, Amazon has decided to challenge this decision in the courts. Our readers may want to pay attention how this lawsuit will develop in the coming months as the result is likely to affect the stock price of both MSFT and AMZN.

Recent research led by Charlotte Kotas of the Oak Ridge National Laboratory compares the cloud offerings by Microsoft’s Azure and Amazon’s AWS. It highlights that:

Advances in commercial cloud computing necessitate continual evaluation of the cloud’s performance on a variety of applications…

Which cloud platform is the cheapest for a given use case depends on the computation and communication patterns of the application. This study finds that at the point in time that the tests were run, the AWS c4.8xlarge was cheaper in terms of raw computing, while Azure’s H16r had cheaper bandwidth.

We are likely to hear about more about the fierce battle for cloud leadership in 2020 too.

Short-Term Technical Charts of MSFT Stock Urge Caution

Over the past year, Microsoft stock is up 35%. Due to the recent impressive run up in the MSFT stock price, short-term technical indicators have become somewhat overextended. Investors who pay attention to short-term oscillators should note that MSFT also looks “overbought.”

So, in the coming days, there might be some profit taking. It’s likely that a lot of good news has already been priced into the MSFT stock price.

Microsoft stock’s beta is 1.24, which means its volatility on average is 20% higher than that of the stock market. Therefore, if the industry or the overall market declines, then shares may also be adversely affected.

Microsoft stock is momentum-driven, so it usually experiences big price swings after MSFT reports earnings. In other words, it can easily gap up if the numbers are better than expected, or the stock can easily gap down if the numbers disappoint too.

It is likely that the recent rally of Microsoft stock may stop in the short run as some investors take profits. Then the share price may stabilize as it gets ready for the next leg up.

So, Should Investors Buy Microsoft Stock Now?

I believe MSFT stock would be an important addition to any long-term portfolio.  Investors who are seeking capital appreciation should keep in mind Microsoft’s dominant position in the cloud sector. Earnings are likely to boost Microsoft stock in the coming months, but just as crucial is management’s strategy for the company.

If you already own Microsoft stock, you might want to hold onto your shares. That said, if you are worried about short-term profit taking, then you may consider placing a stop loss at about 3% to 5% below the current price point to protect your profits to date.

If you have experience with options, you may also consider using a covered call strategy with an approximately two-month time horizon. In that case, you may, for example, buy 100 shares of MSFT at a limit price of $152 and, at the same time, sell a MSFT Dec. 20 $152.5 call option.

The $152.5 option is slightly out-of-the-money, offering some downside protection in case of volatility and a decline in MSFT stock. It would also allow investors to participate in any advance by the stock until the option expires. This call option will stop trading on Dec. 20, 2019 and expire on Dec. 21.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.