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Get Ready to Buy Microsoft When This Market Quirk Hits

- By Sangara Narayanan

If you have been investing for any significant length of time, then you know the importance of patience in investing.

The stock market is always irrational and can push stock prices to stratospheric heights when things are good and can punish with even more vigor when things don't go as planned. A patient investor will be able to use a stock's roller coaster ride and turn it into an advantage, but the key here is knowing the company and sticking with it, which means buying when everyone is selling - easier said than done, unfortunately.


What's happening with Microsoft?

Microsoft (MSFT) has been trading near its all-time highs and has been in the process of making new highs for the past several months. The stock price has risen by more than 20% in the last 12 months, and the price-sales (P/S) ratio is already pushing 6, but the problem is Microsoft is yet to return to a solid growth period. The Redmond, Washington, giant reported a near-flat growth during the second quarter when it saw sales reach $24.090 billion, an increase of $294 million over the prior period. In percentages, that's 1.2% growth.

Then why is the stock making all-time highs at an alarming frequency? That's because the company has completely transformed its business lines; it's more cloud focused now and has pushed declining Windows revenue to the background. Its SaaS product portfolio is the best in the world of office productivity right now, and there is huge potential for growth in this segment along with growth for IaaS in the form of Microsoft Azure.

The market has watched this transformation for the past several quarters and has rewarded the company with high valuations for deftly maneuvering into solid growth areas without killing itself in the process. The problem with stocks going up and up without taking a break, though, is that even small and insignificant - but negative - news can hit it hard. It will be temporary, however, and the stock will continue its upward surge over time. The higher the valuation multiples, the bigger the swings will be after every news cycle.

An analogy to explain this quirk of the market

Netflix (NFLX) is a classic case for this phenomenon - a surging stock that is on a constant upward trend, with several quarters of shocking downward moves due to either bad news or just from a plain bad quarter. In Netflix's case, every time the subscriber growth takes a hit the stock dives down, and it will start surging again once the numbers get back on track. The root cause for that volatility is Netflix's high valuation multiples because at that level things are going to move fast.

How you can take advantage of that same quirk

Microsoft may have already entered that phase. It's a great stock because it's a great company with a clear objective to dominate the enterprise software segment, but the stock price is already pushing six times sales. The odds of a slowdown in cloud revenue seem very low as the entire segment is still in early adoption stage, but if there is a bad surprise or even a one-time event hitting the company, the stock price will quickly move downward.

If you are a long-time investor, don't let that opportunity go because Microsoft is not going to give many of those in the near term.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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This article first appeared on GuruFocus.