If there’s any single lesson I could boil down in my years as an investor and former financial journalist, it’s this: Wall Street reserves the right to change its mind … and not tell you.
That’s why I think it’s about to part ways with one of its favorite stocks of the past decade: Microsoft Corp. (Nasdaq: MSFT).
Microsoft’s Stock Is Just Below Its All-Time Highs
As I noted in my original New Year’s prediction, there’s no question the company is firing on all cylinders.
The stock is highly touted and owned by most big hedge funds. It’s at the top of everyone’s buy list and on the lips of every strategist on CNBC.
Out of roughly two dozen firms with published opinions on Microsoft’s stock, 22 rate it the equivalent of a “strong buy.”
Here’s why I expect shares to fall 30% or more by the end of the year.
Watch out for Wall Street’s Trap
When institutional traders decide a favorite stock has reached its zenith, they’ve already got one foot out the door. But they have one last problem.
They need buyers. They need to convince someone else to take the other side of the trade.
That’s where retail investors like you and I come in.
We’re supposed to be the poker game patsies — the rubes who fall for their sleight of hand shell game.
Perhaps this chart, showing Microsoft’s sky-high price-to-earnings (P/E) ratio, may keep you from falling into their trap.
Microsoft’s P/E Ratio Is Way Too High
(Source: Capital IQ)
The P/E ratio tells us how much we’re paying to own a company’s shares, relative to its profits.
Microsoft’s P/E ratio is over 30.
The P/E ratio is also a measure of a stock’s popularity. The more optimistic investors feel about a company’s prospects, the more likely they are to pay a higher price to own a share of the profits.
In Microsoft’s case, the last time the company was this popular — with a P/E ratio of 30 or higher — was back in 1999 and early 2000.
You know what happened next.
2 Scenarios for Microsoft
Don’t get me wrong. Microsoft’s profits are still growing.
Analysts expect the company to earn $5.69 a share this year, rising to $6.20 a share next year and $7.19 a share in 2022.
That works out to a growth of about 13% a year.
But Microsoft’s P/E ratio implies that investors expect the company to grow its profits at a 30% annual pace.
That’s an unsustainable situation, in my opinion.
One of two things is going to happen:
- Microsoft finds new ways to rapidly increase its annual profit growth. Perhaps its foray in recent years as a cloud computing competitor against Amazon will pay off in a big way.
- The stock’s share price falls back to a level that more closely matches its profit growth for the future.
I’m betting on No. 2. That’s why I expect the share price to fall more than 30%, to $120 by the end of the year, for starters.
Why that price?
If we divide $120 by Microsoft’s expected 2021 profits of $6.20 a share, that’s the level where we get a P/E ratio of 20.
And at $120, investors would still be paying a sizable premium to own the stock.
Best of Good Buys,
Editor, Total Wealth Insider
P.S. Microsoft isn’t the only Wall Street loved stock I recommend you dump ASAP. In my latest report, I list nine other stocks you need to sell today — or you risk losing your hard-earned money. To learn how to get your copy of 10 Stocks to Dump Right Now, click here.