Event: MSFT reports its Fiscal Q4 earnings tomorrow after the close. The options market is implying about a 4% one day move, which is below the 4 qtr avg of about 4.75% but just about in line with the 8 qtr avg of about 3.75%.
Sentiment: Wall Street analysts have been relatively mixed on MSFT, with 15 buys, 24 holds and 4 sells, with an average 12 month price target of $44.02. The stock has been one of the mega cap leaders in 2014, up 19.5% year-to-date, and is trading at its highest level since early 2000. Short interest is negligible at 1% of float.
Options Open Interest: Calls have been much more active over the past month, as the stock has rallied to new highs. The 1 month average call to put ratio is around 1.9 to 1. In terms of total open interest, calls also outnumber puts, but by a lower margin of about 1.45 to 1.
For shorter-dated options, the Aug16th 45 calls have over 90k of open interest. The Sept 44 calls have over 50k of open interest. Farther out, the Jan15 35 and 40 calls both have over 100k of open interest, while the Jan16 45 calls have over 60k of open interest.
Price Action / Technicals: MSFT has broken out to incremental new long-term highs throughout 2014:
The stock convincingly cleared above the 2001 and 2007 highs, both near $38, in March, and the stock held above that prior resistance on the spring selloff in the market. In the past week, MSFT moved cleanly through the mid-2000 high near $42 as well, reaching its highest level since early 2000. On the upside, the only real resistance before the all-time high of $60 is likely at the psychologically important $50 level.
The breakout from the long-term base certainly looks impressive technically. Of course, MSFT has rallied nearly 70% in the past 18 months, so some consolidation might be in order:
The rising 50 day ma is now around $41.25, and the rising 200 day ma is around $38.40. As long as the 200 day ma holds, the long-term uptrend remains in tact.
Fundamentals/Valuation: MSFT stock has found life in the past 18 months after years of stagnation. As Dan discussed in today’s MorningWord, it’s tough to say whether the stock is higher on the company’s own merits, or on the relative valuation vs. the market:
At this juncture, the enthusiasm for MSFT and INTC is likely due to the same enthusiasm that has spurred the utility sector to the top spot in 2014 – perceived defensiveness. Neither company has made any groundbreaking strides in the past couple of years. While the PC cycle has turned in their favor, that has occurred before in the past decade, but was not enough to lead to clean breakouts as has happened this time around. The long-term competitive situation remains difficult for both companies, but investors have decided that they are willing to pay up for the stocks since they are more attractive on a relative basis (compared to the overall market) than they have been at most points in the past 10 years.
Speaking of that relative valuation, the trailing 12 month P/E for MSFT after the recent rally hit a new 5 year high:
At a 16x P/E, MSFT has approached the broader market multiple, playing catch-up over the past year. Investors have been enthused by the cultural and workforce changes instituted by the new CEO, Satya Nadella.
However, Commercial Licensing still makes up more than 50% of the company’s revenues, an indication that MSFT is still a software business at its core. The main question for MSFT is whether it will be able to grow its other businesses quickly enough to offset the gradual decline in Microsoft Windows.
Volatility: 30 day implied volatility in MSFT hit a 2 year low in mid-June, but has picked up ahead of the earnings report as well as the breakout to new highs in the shares:
Implied volatility is likely to move back into the high teens after the report, but the move to new highs might be a reason for more volatility going forward.
Our View: Expectations are elevated into tomorrow’s report given the recent breakout in the shares. However, the strong technical position for MSFT, especially on the long-term chart, likely means decent buying support on any weak report. Fundamentally, the company looks like a long-term bet on Mr. Nadella and his new initiatives, amidst a competitive environment for enterprise software. We are not enthusiastic about his long-term prospects, but the technical situation certainly looks bullish.