Microsoft as another potential example of a 'quality bubble'; Why my friend Doug Kass is short the stock
If you've been following along with my e-mails recently, you'll recall that I've been noting some stocks as examples of a "quality bubble"...
Just yesterday, I took a quick look at retailer giant Walmart (WMT). I concluded that, as great of a company as it is, its stock is likely another example of the widespread "quality bubble" I've been warning about in light of that fact that it's trading at 42 times trailing earnings and a 20-year-high 1.1 times revenues.
Then, another popular blue-chip stock, Microsoft (MSFT), caught my eye because my friend and veteran investor Doug Kass of Seabreeze Partners sent out a missive yesterday on why he's short the stock. He gave me permission to share it with my readers today:
The Problem With High Stock Prices
- MSFT is trading up $8 on this news: Microsoft Plans New $60 Billion Buyback, Raises Dividend 10%.
- I would argue that this reaction is plain silly.
- Higher stock prices are the enemy of the rational investor.
Just like with Nvidia (NVDA), the buybacks and dividend increases at Microsoft do not move the needle.
As Doug continued:
These announcements are aimed at retail investors as well as algorithms that probably use AI and therefore cannot do math and understand this is meaningless. If good things were happening, these companies would not have to resort to these games:
A $60 billion buyback on a $3.2 trillion market cap is only about two percent of the outstanding shares. Moreover, the last buyback of $60 billion from 2021 was not completed.
And a 10% dividend hike barely moves the needle on a base of a 0.77% yield.
Importantly, when we combine them, it's less than 3% – and that's before all the stock options, which probably means they are not even retiring shares anymore...
So with this bearishness in mind, let's take a quick look at Microsoft today through my "first look" lens...
Like Walmart, its stock chart since its 1986 initial public offering ("IPO") is a thing of beauty:
Not surprisingly, the company's revenue and profit growth have been exceptional over the past 20 years:
Meanwhile, Microsoft's high and rising cash flow from operations combined with historically low capital expenditures ("capex") have resulted in massive free cash flow ("FCF") over the past two decades:
While this is incredible performance, one small area of concern is that Microsoft's capex has skyrocketed recently. It has tripled over the past four years to $44.5 billion in the most recent fiscal year ending on June 30, 2024 – and the company projects that it will spend more than $50 billion in fiscal year 2025 as it invests heavily in the AI arms race.
In summary, Microsoft has been one of the most extraordinary growth stories of all time. That's reflected in its market cap, which as of yesterday's close is second only to Apple (AAPL) by slightly less than 2%.
And the company undoubtedly has a bright future. It has been a long-term holding in our flagship Stansberry's Investment Advisory newsletter since February 2012. Investment Advisory subscribers who followed the advice to buy back then – and held on this whole time – are up a staggering 1,389%.
But this doesn't necessarily mean Microsoft will be a massive outperformer going forward from current levels...
As I've shown again and again, investors who chase historical performance and overpay for a stock can lose a lot of money very fast.
For a good example of what I'm talking about, you don't need to look any further than Microsoft itself...
Zooming in on the stock chart above, let's look at how Microsoft performed from the beginning of 2000, near the peak of the Internet bubble, through 2016:
You can see that, from its peak around $60 per share, it collapsed by 75% to a low of around $15 per share in March 2009 and didn't surpass its prior peak for nearly 17 years!
Why did the stock decline so much? Did the company's revenues and profits shrink?
Not at all – in fact, they grew strongly. Take a look at this chart:
So what explains the terrible stock performance?
In a word: valuation.
As you can see from these next charts of Microsoft's forward price-to-earnings (P/E) and trailing price-to-sales (P/S) multiples, Microsoft was trading at absurd multiples of 70 times forward earnings and nearly 30 times revenues at its peak in early 2000:
These multiples reflected investors' impossible, bubble-driven expectations. When the company failed to meet them, the stock cratered.
And as you can also see in the charts above, in 2012 those multiples were still at a low level historically when the Investment Advisory team added the stock to the model portfolio.
So where are we today?
Well, at 32.7 times forward earnings and 13.2 times revenues, the stock is nowhere near the bubble peak multiples of 2000. But the valuations are certainly very rich – and close to 22-year highs.
Can Microsoft grow fast enough to justify its current valuation?
It's not out of the question, of course... But given that Microsoft is now one of the largest companies in the world with a colossal $245 billion in annual revenues, I think it's unlikely.
That said, if I had owned it for a long time and had big gains, I would certainly want to continue to let it run. That's what we've done in the Investment Advisory.
But as I said in my September 5 e-mail – using Nvidia (NVDA) and its incredible long-term gains as an example – the answer might be different if a stock like this becomes such an outsized portion of your portfolio that you're losing sleep at night.
Or if position size isn't an issue, perhaps you're just worried that the stock has gotten ahead of itself and you don't want to give back your big gains.
As I said in that e-mail regarding Nvidia and this kind of "high-class problem":
Keep in mind that there's no "right" answer – or a one-size-fits-all solution – here...
But if I had this high-class problem, I would want to let the stock run, but have a series of stop losses in place – let's say, starting with selling 20% of my position if the stock fell 20%. Then, if it dropped 30% from its peak, I could sell another 10%... down 40%, another 10%... and finally another 10% if the stock got cut in half...
This hypothetical stop-loss strategy for Nvidia I've outlined here could be different a month from now – and would certainly be different for another stock. Each situation is unique.
And of course, all investors have different appetites for risk and how much money they're willing to potentially lose... Again, there's no one-size-fits-all perfect answer.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.