Valuation analysis for Microsoft Corporation (NASDAQ:MSFT)

October 14, 2014, 13:30 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

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At first glance, Microsoft Corporation (NASDAQ:MSFT) looks extremely rich on an earnings valuation basis.  EPS growth is negative using a trailing 12 month EPS analysis.  The chart below shows us that EPS growth has been negative since the second quarter of 2013, but interestingly the stock price has increased even in the face of negative EPS growth.

During that time, between the second quarter of 2013 and now, the PE multiple for Microsoft expanded from under 10 times earnings to almost 17 times earnings.  That is a massive expansion in the multiple, and when earnings growth is negative it raises serious red flags.

However, one thing exists at Microsoft that does not usually exist when companies experience negative earnings growth.  Typically, when a company experiences negative earnings growth they have corresponding negative revenue growth, or at least no growth in revenue.  That is not the case for Microsoft.  Instead, Microsoft has experienced solid revenue growth in the face of the decline in earnings growth, which suggests that the company may be making a conscious decision to reinvest added revenues instead of bringing those revenues to the bottom line.  We cannot be sure of this, the other possibility is that margins are contracting, but the increase in PE multiple seems to suggest that the company will be able to bring earnings to the bottom line at some point.

Technical take:

According to our real time trading report for Microsoft the stock seemed to be in the process of increasing towards longer term resistance recently but it turned down abruptly and instead of testing resistance the stock has begun to break below longer term support as that is defined in our report.  If the stock continues to break support that support level will convert into a resistance level and the door will be wide open for the stock to fall according to our technical observations.  The stock must hold support in order for it to remain attractive to us on a technical basis but it is starting to break.

Summary:

The multiple expansion experienced in shares of Microsoft can be attributed to revenue growth, but earnings growth clearly does not exist.  There are questions, unanswered, but hopeful investors it seems.  The problem is, for investors who care about price shares of Microsoft are threatening to break down.  If price does matter and support levels break than there are no reasons to buy shares according to our price based analysis.  Regardless of the potential of Microsoft to bring higher revenues to the bottom line in the future breaks of support would be major red flags according to our analysis and if any doubt exists about the company's ability to bring revenue growth to the bottom line serious multiple contractions could follow, so we consider Microsoft to be on the cusp of a very high risk scenario.

Support and Resistance Plot Chart for

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