Bearish Microsoft Trade Idea With Dangerous Setup into Earnings
As the computing giant prepares to report its latest earnings, it faces a harsh stock setup.
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Tonight's the night. First quarter earnings season kicks back into high gear after a couple of lighter days passed on the calendar.
The Mag 7, or should I say, the "Drag 7" will be in focus both today (Wednesday) and tomorrow (Thursday). Meta Platforms META and Microsoft MSFT will go to the tape with their numbers on Wednesday evening. Then, we'll hear from both Amazon AMZN and Apple AAPL after Thursday's closing bell.
Though at times I have invested in and traded all of these names, one is near and dear to my heart. They say not to fall in love with your favorite stocks, and I did not, though this unemotional approach is more difficult to achieve than some might think. Microsoft has made my book some nice dough over the years and had once been the heaviest weight among all of my allocations. That was really from mid- to late 2022 all the way through late 2024.
That's when I got a whiff that maybe MSFT was not going to perform as it once had for me and took it down a few notches. Then, I took the name out of my "top five" and then my "top 10" and then small, only to be followed by a complete exit. That came earlier this year.
So, going forward, is there room for a re-initiation of MSFT to my pad? Let's at least think and talk about this...
What's to Come
On Wednesday evening, Microsoft will release the firm's financial results for the three-month period ended March 31, which was the firm's fiscal third quarter. Wall Street is looking for a GAAP EPS of $3.22 on revenue of $68.44 billion. This would compare well (+9.5%) to the year-ago comp of $2.94, while reflecting year-over-year growth of 10.6%.
The firm had guided toward a revenue midpoint of $68.2 billion (when combining all of the firm's sector guidance) back in late January, which readers may recall, was seen as disappointing at the time by Wall Street. Of the 31 sell-side analysts that I can find that cover MSFT, 20 have increased their earnings estimates for the firm since the start of the quarter to be reported, while 11 have decreased their earnings estimates.
Tonight's Focus
There are a few areas that will come into focus this afternoon. Revenue provided by the Intelligent Cloud grew 18.7% for the fiscal second quarter, producing growth in operating income of 13.7%. Within this segment, the top performer was Azure, which provided sales growth of 31% for that quarter. That was, however, disappointing at the time. Getting this growth back on track, though 31% growth sounds great, is key. What is also key will be the firm's capex spending and capex spending plans as the economy slows.
In order to keep moving forward on the firm's generative AI initiative and on its provision of cloud-based services, the Productivity & Business Processes segment will have to continue to be a consistent provider of operating and free cash flows. The More Personal Computing sector, while not growing in terms of sales, has been a driver of improved operating margin. That trend must remain on track.
The Chart
What's troubling? Even with the stock having been rerated lower in terms of valuation this year, it still trades at 30-times forward-looking earnings. The chart is interesting, but not really set up for a post-earnings rally.
Readers will see, as the broader market reacts poorly to the contractionary Q1 GDP data and the weak print for April ADP private sector job creation, that over the past month or so, MSFT stock has developed a rising-wedge pattern of bearish reversal. The stock has retaken its 21-day EMA and 50-day SMA, which likely pushed some portfolio managers to increase long side exposure. The stock remains well short of the all-important 200-day SMA.
The stock should test that 50-day SMA from above Wednesday morning. Relative strength has been improving but remains neutral. The daily MACD has been improving as well. That said, the 26-day EMA remains below the zero-bound, and that's less than bullish. For the wedge pattern to continue, the share price would have to move toward the rising lower trendline, having recently bounced off of resistance at the upper trendline.
I could be wrong. I'd love to be wrong, but I see this as a moderately bearish setup. Given the dangerous nature of these earnings in the volatility that the release could produce, I would rather get long a bear put spread than get short the stock.
My Idea (Minimal Lots)
- Purchase one May 2 MSFT $385 put for about $7.95
- Sell (write) one May 2 MSFT $375 put for a rough $4.25
Net Debit: $3.70.
Note: The idea is to risk $3.70 to try to win back up to $10. $3.70 would be the max lost on this spread. The max profit should the shares close below $375 on Friday would be 170%.
Note Two: Obviously, the stock and the options used may have to be adjusted by the time of publication. The stock is in play and the market is volatile this morning.
At the time of publication, Guilfoyle had no positions in any securities mentioned.
