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Microsoft Corporation (MSFT) Stock Is Priced for Perfection, So Be Careful

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

For the better part of the past three-plus years, I have loved Microsoft Corporation (NASDAQ:MSFT) stock.

MSFT Stock: Microsoft Corporation (MSFT) Stock Is Priced for Perfection, So Be Careful
MSFT Stock: Microsoft Corporation (MSFT) Stock Is Priced for Perfection, So Be Careful

Source: Shutterstock

My affinity started in February of 2014, when forward-thinking Satya Nadella was appointed CEO. He brought with him a new way of thinking about Microsoft. No longer was it this dinosaur of a company getting left in the dust by quicker-growing cloud companies. Nadella promised to transform Microsoft into a cloud giant.

And he has done just that. With Office 365, Azure, Dynamics and much more, MSFT has transformed into a cloud company with robust growth potential. The story is a lot more exciting now. So are the numbers.

And so is the stock.

Since Nadella was appointed CEO in February 2014, MSFT stock has doubled versus a 40% gain for the S&P 500.

But as MSFT stock keeps heading higher, I am starting to fall out of love. Microsoft is trading at 15.6 times trailing Ebitda. That is about as richly valued as this stock has been in the past 10 years. It’s also trading at 20.1 times next year’s consensus earnings estimate for growth that is pegged at merely 10% per year over the next five years. That is a pretty big multiple for not that much growth.

Overall, it is pretty safe to say that MSFT stock is priced for perfection.

So when perfection doesn’t happen, it has a lot to lose. Investors need to look no further than Nvidia Corporation (NASDAQ:NVDA) for proof that even the smallest imperfections can cause sizable dents in richly valued tech stocks.

Unfortunately, I think Microsoft is due for some imperfect quarters in the near future. That implies sizable downside risk ahead for MSFT stock.

The Warning Signs at Microsoft

The Surface may be losing some of its lead.

For a while, the Surface was gaining momentum in the tablet market. Not too long ago, the laptop market and the tablet market were rapidly converging. The convergence gave birth to the era of 2-in-1’s, an area where the Surface excelled and where the iPad failed. Consequently, Surface revenue took off and iPad revenue tailed off.

But that trend appears to be switching. The iPad is back. After 13 consecutive quarters of negative unit growth, Apple Inc. (NASDAQ:AAPL) reported that the number of iPad units shipped last quarter actually rose 15% year-over-year. That is the iPad’s first positive unit growth quarter since the first quarter of 2014.

Meanwhile, Microsoft Surface revenues decreased 2% last quarter versus a 9% increase in the same quarter one year ago.

Big picture here is that Surface revenues are falling off, while iPad revenues are picking back up.

Granted, the Surface isn’t the meat of Microsoft’s growth narrative, but it’s still a part of it. And when MSFT stock is trading at a near 10-year-high valuation, any hiccup in operations will be noticed by investors.

Elsewhere, revenue growth from the company’s search engine, Bing, is slowing — search advertising revenue excluding traffic acquisition costs increased 10% last quarter, versus 16% in the overlapping period one year ago. So is growth from Office 365. And growth in the Windows OEM segment.

Bottom Line on MSFT Stock

The cloud growth narrative remains robust, but warning signs are piling up elsewhere at the company. Normally, this wouldn’t be a problem. But MSFT stock is currently priced for perfection. That means any hiccups in the company’s growth narrative will be felt by the stock.

All I really have to say about MSFT stock at this point can be summed up in one sentence.

It’s about as richly valued as it has been in 10 years, so be careful.

As of this writing, Luke Lango was long NVDA.

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