Microsoft Corporation (NASDAQ:MSFT) was one of the best mega-cap stocks of 2022 despite its own 30% fall. Just ask Meta Platforms (META) and Amazon.com (AMZN) investors. Wait, why do I feel like I am talking to myself? Because I hold all three of these and if forced to hold only one of these three for the next 10 years, I think I will pick Microsoft in a beat.
But When Will The Sell Off End?
Technology stocks don’t need much help to sell off these days, albeit justifiably most of the times. If employment numbers come out below expectations, the Fed somehow puts a dampener. If some Fed official speaks with a dovish tone on that rare blue-moon night, inflation numbers decide to go in another direction. If inflation numbers come out below expectations, China does something. You get the point. And analysts are glad to help always. UBS slashed their price target on Microsoft to $250 and the stock promptly responded by selling off 5% as Seeking Alpha has covered here. I wrote this article just a few short days ago arguing that Microsoft was still looking the strongest out of all the mega-cap tech stocks and that never in its 30+ year history as a public company has the stock had consecutive two meaningful down years. Since then, the stock has sold off 6% (mainly thanks to UBS) while the market is about break-even.
I am not panicking here but it is worth stating that in the current market environment, the downside tends to overshoot, just like how the upside knew no limits till 2021. Hence, it is very plausible that this Microsoft selloff may accelerate from here, especially considering the fact that stock is still trading at forward multiple of 24.
To answer the question in the section heading, no one knows when the sell off will end. But every investor would do well to have a clear list of:
- Various price points they’d like to buy (initiate or add to) a stock
- reasons why they believe that price point is a good buy
- means to acquire such shares at those price points
This article presents all the above for Microsoft. Let us get into the details.
What’s the price point?
In interest of full disclosure, I did add to my position recently at $235 but at $200, I’d likely be buying quite a bit more for the reasons mentioned below.
5 Year Low PE
Microsoft is trading well below its 5 year average multiple of 35 and I believe we can all agree that Mr. Market is unlikely to gift such valuations in the near future, at least until the Fed starts cutting rates. In other words, don’t hold your breath. But at $200, should forward EPS hold, Microsoft’s multiple will be well below its lowest earnings multiple in 5 years, at 20.90.
When you factor in the expected growth rate of 13%, Microsoft’s price to earnings/growth ratio (“PEG”) will be 1.60 at $200. That is still above the textbook definition of undervaluation but when you consider that Apple (AAPL) has a current PEG of 2.50, Microsoft’s potential undervaluation at $200 becomes apparent. I am using Apple as the comparison here for a few reasons: (1) Apple and Microsoft have largely outperformed the other mega-caps since the sell-off began (2) Apple is, or at least was, often regarded as the technology stock that doesn’t get rich multiple awarded to it the way some of their peers like Amazon.com, Inc. (AMZN) and Meta Platforms, Inc. (META) enjoyed in the past. (3) Both pay a dividend that has plenty of room to grow.
Three Year High Yield
Speaking of dividends, Microsoft is very likely to announce at least a 10% dividend increase this year as covered in this article. That would place Microsoft’s annual dividend at about $3 per share, giving it a yield of 1.50% at $200 per share. That, as shown below, is the highest Microsoft has yielded in the last 3 years.
Technical Support
With today’s 5% sell off, Microsoft has now moved below its 5-Day moving average as well on top of the pressure that existed on the 20-, 50-, 100-, and 200-Day moving averages. This tells me the down trend still has ways to go. But the more important question is, where will it stop?
It is impossible to predict but the early $200s has provided a lot of support as shown in the chart below. But the market environment right now is vastly different from those days where the stock bounced off $200s consistently. So, further downside below $200 cannot be ruled out.
Double Bear
A 20% fall is generally considered a bear market for the overall market and individual stocks. At $200, Microsoft would have lost a little more than 40% (double bear) from its all time high of ~ $340 reached in November 2021. That does not many Microsoft a buy by and of itself but even the most aggressive bargain hunters will look at a 40% fall for one of the most profitable and sticky companies in the world as an enticing opportunity to buy.
Means to the end – Selling $200 puts
With those reasons supporting a $200 buy out of the way, let us now look at a way to position yourself to acquire Microsoft at that price. If you like Microsoft as a company and stock but believe, like I do, but that the bottom is not here yet, then consider selling cash secured puts as described below. This allows you to stay in the game while not risking your entire capital right away.
Bear in mind, selling puts in down trending markets like this is a bit riskier than in up trending markets as your strike price may be reached quicker than you think. Hence, be sure about the two cardinal rules of selling puts, for most retail investors: (a) Do not go on margin and (b) Be really sure that you wouldn’t mind owning the stock at the strike price.
With that being said, let’s look at the options chain highlighted in red above.
- Strike Price: $200
- Expiration Date: April 21st, 2023
- Premium: $5.60/share, for a total of $560 for each contract (100 shares) you are willing to sell.
In simple words, the put seller will be collecting $560 to buy 100 shares of Microsoft at $200 if the stock reaches $200 or below by April 21st, 2023.
Return: The premium collected ($560) for setting aside $20,000 represents a return of 2.80% for about three and a half months.
Outcome #1: If Microsoft stays above $200 by the expiration date, the put seller retains just the premium above and will not be obligated to buy the shares.
Outcome #2: If Microsoft goes below $200 by the expiration date, the put seller will be forced to buy 100 shares at $200, irrespective of where the stock trades at that time. Keeping the premium netted in mind, the average cost in this case will be $194.40 ($200 minus $5.60).
Outcome #3: As an option seller, one can “buy to close” anytime instead of waiting till the expiration date, irrespective of whether you have made or lost money on the premium.
In short, you either end up owning Microsoft about 13% below its current price and/or get a nearly 3% return for setting aside $20,000 (per contract).
Conclusion
Microsoft remains a buy for me but the market looks primed to present more opportunities to buy it lower. Selling put at lower strike prices allows you to acquire stocks you like at lower prices and can be part of a long term portfolio strategy as long as the risks are understood.
What do you think about Microsoft at $200? Please leave your comments below.
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