Microsoft (MSFT) Overdue for Intermediate Correction

Dow component Microsoft Corporation (MSFT) reports earnings after Wednesday's closing bell, with Wall Street analysts expecting earnings per share (EPS) of $1.38 on fiscal fourth quarter 2020 revenue of $36.55 billion. The stock rose 1% after Microsoft beat top- and bottom-line third quarter estimates in April and then added to gains into July's all-time high at $216.38. It is consolidating near that price level ahead of the earnings news, in a perfect position to break out in reaction to strong metrics.

Key Takeaways

  • Microsoft stock has booked outstanding returns in the past four years.
  • Earnings and profits have held up well despite pandemic headwinds.
  • Technical readings warn that the stock is overbought and overdue for a correction.

The pandemic has barely affected Mr. Soffee, which is now the second strongest component in the Dow Jones Industrial Average, just behind Apple Inc. (AAPL). Microsoft has beaten earnings estimates nearly every quarter and ranks among the elite in big tech stocks after three years of outstanding returns. Stifel analyst Brad Reback just added to strong optimism heading into the report, noting, "We expect healthy upside to EPS/revenue as we believe Microsoft's various properties (Azure/Office365/gaming) are net short- and long-term beneficiaries from the pandemic."

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). The P/E ratio is also sometimes known as the price multiple or the earnings multiple.

Microsoft Long-Term Chart (1999 – 2020)

Chart showing the share price performance of Microsoft Corporation (MSFT)

The stock ended a strong uptrend at a split-adjusted $59.97 in December 1999, marking a high that wasn't challenged for the next 16 years, ahead of a steep downtrend that initially found support in the upper teens. It underperformed during the mid-decade bull market, topping out in the mid-$30s in 2007, ahead of a major decline that posted a 10-year low during the economic collapse. It then took four years for the stock to complete a 100% retracement into the 2007 high.

Steady upside into 2016 stalled just three points below the 1999 peak, ahead of a historic breakout following the presidential election. That signaled the start of market leadership, with a channeled uptick underpinned by broad institutional sponsorship. The rally paused in October 2018 and resumed at the start of 2019, making rapid progress into the February 2020 high at $190.70. It then rolled over with world markets, hanging tough at a seven-month low in March.

Microsoft Short-Term Outlook

A powerful recovery wave into the second quarter stalled just three points under the February high in May, ahead of a June breakout that attracted steady buying interest. The stock added another 25 points into July's all-time high and eased into a holding pattern ahead of this evening's confessional. Microsoft is now trading about seven points under that peak in a quiet session and could easily break out in reaction to a strong report. 

However, the 20-month Bollinger Band® is signaling the need for caution after hugging the top band for the past 15 months. Specifically, the July price bar has stretched 100% outside the top band, setting off an overbought technical reading that raises the odds for an intermediate correction. It's hard to tell from the current view, but price action generated an identical signal in February, just before a reversal carved the long top shadow and a 58-point decline into the center band.

A Bollinger Band® is a technical analysis tool defined by a set of trendlines plotted two standard deviations (positively and negatively) away from a simple moving average (SMA) of a security's price, but the specific metrics can be adjusted to user preferences.

The Bottom Line

Microsoft is firing on all cylinders, lifting into the second slot in Dow component performance, but the stock is now extremely overbought and in need of a consolidation or correction. Even so, tonight's earnings release could easily trigger a strong, if short-term, "buy-the-news" reaction.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.

Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.