I had recommended Microsoft (MSFT) as a must-own core holding in an article on software shares in December 2018 at 97 with a 120 – 125 target. Mister Softy trades at $136 a share as I write and commands a trillion dollar valuation on the NYSE. Microsoft shares have risen more than four times since Satya Nadella succeeded Steve Ballmer as CEO of the Seattle software colossus in 2013. Microsoft’s ascent was powered by the hypergrowth metrics of its Azure cloud computing and Office 365 franchises even as its Servers and Tools enterprise computing business managed predictable EPS growth despite its sheer scale. SQL Server alone generated $8 billion in sales in 2018 and wrested market share from both Oracle and IBM.
Yet if Microsoft’s risk reward payoff flashed a compelling buy to me when it traded below 100 last December, its spectacular performance in 2019 has totally transformed the risk-reward calculus I use to seek value. Near $140, I believe the shares are overvalued, a symbol of a frothy Big Tech stock market. I would book profits after a 37% rise in the last six months. Microsoft cannot replicate the free cash flow bonanza of the Windows operating system business next year and margin expansion in Azure could disappoint the Street’s uber-bullish consensus.
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At 35 times earnings, any such disappointment would mean a public execution for the shares. With 60% gross margins, Microsoft has got be history’s most profitable business and a money gusher for investors who grasped its seminal role in the global corporate IT ecosystem. Yet there is a time for greed (last December) and a time for fear (now). Microsoft AAA credit rating alone should make it a must own investment for investors living in credit rating challenged countries in the Middle East – but not at 136. Microsoft’s overvaluation suggests a 10 – 15% hit to the shares if Wall Street, a tad complacent about recession risk at 19 times earnings, record low corporate credit risk spreads, scary sector divergences/small stock underperformance and a negative US Treasury yield curve, corrects. I am as certain of an imminent correction in the Dow, which had its best June since 1938. 1938 was a long time ago and I would short Microsoft at 136 for a 120 target.
After so many false starts and execution hiccups in its cloud computing journey, Oracle finally delivered a blowout fiscal fourth quarter with optimistic management guidance and EPS/margins that exceeded Wall Street “whisper number”. Mark Hurd and Safra Catz have finally vindicated their vision for the role of Next Gen databases and cloud IT infrastructure. I went ballistic over Oracle’s growth in revenues to 11.14 billion, better than both the sell side Street analyst models and previous management guidance. Oracle will definitely deliver revenues of $40 billion plus in 2019 and EPS could be $3.8 a share. So I have no problem seeing value in Oracle at 15 times earnings, a Cinderella valuation relative to its global software peers Microsoft and SAP.
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After all, if revenue accelerates, non-GAAP EPS growth could top 12-14%, giving the shares a touch of badly needed valuation rerating ballast. Oracle is also updating its core database and applications software businesses for the cloud centric world. While I concede that a single quarter does not presage a credible turnaround, I do believe that Oracle’s revenue mix is now consistent with accelerating growth even in a mediocre IT spending milieu. My caution on the stock market and search for that elusive ideal entry point makes me reluctant to accumulate Oracle at 58 and change, up 10% since its last earnings report. An ideal entry level would be 50 – 52, which the right option strategies can easily deliver when NASDAQ dips, as it surely will in July or August. It takes time to turn around a software supertanker but Oracle shareholders finally sense a light at the end of a long, long dead money tunnel. For now, I expect my buy/sell price range in Oracle is at 50 – 64.
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