Microsoft’s stock could head for an 11% drop

Michael Kramer and clients of Mott Capital own MSFT.

Microsoft Corp. shares (MSFT) climbed nearly 44% in 2020 while the S&P 500 climbed around 8%. The action’s performance comes as the coronavirus pandemic has changed the way people work and collaborate, as more people work from home. This trend has helped boost Microsoft’s revenue and profits while increasing the market capitalization of companies from nearly $ 500 billion to nearly $ 1.7 trillion this year alone.

Despite the significant gains, someone is betting that the big advance in Microsoft stocks is due to a cooling or a potential drop. The large increase pushed Microsoft’s one-year PE ratio to over 30, its highest level in nearly 20 years.

Hedge against a drop

Massive wins cause someone to cover a long position or bet that the stock will go down using options. On August 26, open interest levels for the September 25 calls of $ 215 increased by nearly 16,000 contracts. Additionally, the open interest level for the September 25 puts $ 205 has increased by roughly the same number of contracts. Data shows that the $ 215 calls were sold for about $ 7.96 per contract, while the $ 205 puts were bought for about $ 3.41 per contract. He created a spread trade and bet or hedge that said the stock would be below $ 205 on the expiration date in September, down almost 11% from its current price of around $ 228. August 27.

Multiple extension

The stock saw a big expansion in multiples in 2020, with the PE ratio hitting around 32 times next year’s budget profit estimates. Part of the reason we have seen such a rapidly growing PE ratio is due to the low interest rate environment with the 10 year yield plunging below 1%. Some investors have pointed to the large gap between Microsoft’s earnings yield and Treasury rates. For this spread to narrow, the earnings yield would have to contract, pushing the stock price higher and thus supporting the higher earnings multiple.

Future growth

Whether the stock can continue to rise or not will largely depend on the ability of the company to continue driving profit growth in the future. Currently, analysts see the company’s profits increase by 12% in 2021, while increasing by 13.6% and 13.4% in 2022 and 2023. The rate of profit growth alone is not enough. to support the high earnings multiple that the stock is currently carrying. Therefore, the company must be able to continue to exceed these estimates and provide upward guidance.

Microsoft stocks have certainly had a fantastic run over the past few months, and although stocks are expected to pause and reverse lower as some traders appear to be concerned this is happening. The business is still well positioned to thrive in an environment where more work is likely to be done at home than in the office. If the long-term growth story persists, then the stock should be rewarded in a low interest rate environment or not.

Michael Kramer is a financial markets strategist and portfolio manager of the Mott Capital Thematic Growth Portfolio.

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