Monday, June 25, 2012

MSFT: The next Apple?

Is Microsoft the new Apple? That was basically the question that drove the news coverage after Microsft, on June 18, announced its first entry into the tablet market dominated by Apple's iPad.

Whether the Microsoft Surface will indeed carve out a viable share of that market remains to be seen. The announcement does, I think, make it worthwhile to take a look at this staid and rather unexciting tech giant.

Microsoft Corp. (MSFT) needs no introduction to anyone. It is as ubiquitous to computing as air is to lungs and water to gills.

The Redmond, Washington company is like the big-box retailer Wal-Mart in a way: Neither is particularly innovative at this stage of their corporate lives, but when they decide to do something new, it's like the shifting of tectonic plates: Massive movements that impact everything.

Both companies are very big and very, very rich.

MSFT on the chart hit a milestone today: It has given back nearly all of the 4% bump it got from the Surface announcement.

This is a stock, in fact, that has gone nowhere for a dozen years. It has been trading within a range from roughly $22 to $32, with the occasional break above and below that range. MSFT is a swing trader's dream.

At present MSFT is coming down from one of its upside breakout attempts, having peaked at $32.95 on March 16 after a run up from $30.30 beginning in January.

The retracement brought it down to $28.32 on June 4, and the price subsequently rose to $31.14 on June 21 before beginning the present decline, which is now in its third day.

The present decline has fallen insufficiently to break the uptrend from January, and the smaller scale uptrend from early June also remains intact. However, to break free of the downtrend that followed the March breakout would require a move back above $32.85.

All of which is very confusing. I look at it this way: From small scale to large, MSFT is in the third day of a downtrend within a larger uptrend lasting weeks within a downtrend lasting months within an uptrend lasting half a year within a sideways trend spanning more than a decade.

On the books, Microsoft looks curiously like a growth stock, the opposite of the stagnation shown on its chart.

It has return on equity of 38%, with low long-term debt amounting to just 17% of equity.

Institutions own 65% of shares, which is a bit on the lower side, yet the price has been bid up so that it takes $3.53 in shares to control a dollar in sales. Based on the financials, this is an expensive stock.

The stock has been profitable for at least the last 11 quarters, with an upside earnings surprise in each. Earnings growth accelerated through 2010 but from 2011 onward has been more in a holding pattern.

I give Microsoft an enthusiasm index of 27% among analysts, using a system that gives positive weight to Strong Buy recommendations, negative weight to Hold, Sell and Strong Sell recommendation, and ignores Buy recommendations.

(Apple, by comparison, has an enthusiasm index of 94%.)

MSFT on average trades 48.3 million shares a day. It has, no surprise, an awesome selection of option strike prices with very narrow bid/ask spreads.

Implied volatility stands at 29%, in the upper half of the six-month range. Options are pricing in confidence that 68.2% of trades over the next month will fall between $28.60 and $30.98.

In terms of current valuation, both calls and puts have volume above their five-day moving average, skewed toward the call side. That means that there is active interest in trading.

MSFT is trading below the range containing 68.2% of transaction prices over the last five days, suggesting that it is relatively inexpensive.

The company next publishes earnings on July 19. It goes ex-dividend on Aug. 14 for a quarterly payout yielding 2.69% annualized.

Decision for my account: I like MSFT on the financials and the business model, and obviously for its dominance of its market. The problem is the price is going nowhere. That problem impacts strategy choice, not the decision to open a position.

I could see playing MSFT as a diagonal spread, continually lowering the basis by selling front month calls against long back month calls. Or as a covered call, for traders wanting to forego the leverage options (which reduces risk) in in favor of capturing the dividend. A good swing trader to could play it as a directional play, once the direction becomes clear.

For my own account, I've opened a diagonal spread, long the Januay 27 calls and short the July 31 calls.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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