Microsoft Post-Earnings Dip Shows Tech Stocks Not as Safe as They Seem

Fair is foul and foul is fair. Up is down. And tech stocks are now defensive stocks. That last statement may not be exactly true, but it sure seems like it these days. Microsoft (NASDAQ:MSFT) is looking more and more like a forever stock. But as MSFT stock is showing the day after its earnings report, let the buyer beware.

Despite posting a beat on both the top and bottom line for its fourth-quarter earnings report, MSFT stock dropped 2% in overnight trading and has only recovered slightly in mid-day trading.

This touches on something that Karen Langley reported in the Wall Street Journal. Langley describes how many tech stocks have been rewarded during this pandemic.

“Shares of many technology and pharmaceutical companies have looked like safety plays during the pandemic. Other stocks that have long been considered defensive bets during a downturn, such as those of real estate and utility companies, have suffered steep losses.”

Tech stocks have become winners due to more people staying home

In the article, Langley writes that investors are finding this shift to be a logical response to the lockdown measures brought about by the novel coronavirus. While Amazon (NASDAQ: AMZN) was already a household name. Many other technology stocks, such as Docusign (NASDAQ: DOCU) are now becoming an established part of the customer experience.

Consider the housing market. Realtors are now conducting virtual tours via Zoom. And instead of buyers and sellers convening at the title office for a signing ceremony that rivals a peace treaty, documents are being electronically sent and signed.

And Microsoft has a piece in this new economy, which as consumers are discovering is not really new at all. 

How Microsoft benefits from this flight to safety

Many workers are logging in from home. And in an effort to stay connected to their fellow employees, they’re using tools such as Zoom (NASDAQ: ZM) and Slack (NYSE: WORK). But Microsoft is a major player in this area. The company’s collaboration tool, Microsoft Teams, is growing in popularity, particularly in enterprise settings where it’s likely that Microsoft products were already seeded.

Teams is part of Microsoft’s Productivity and Business Processes unit. That unit delivered $11.75 billion in revenue in the latest quarter, a sequential increase of 6%. Should investors be concerned that this part of Microsoft’s business did not meet analysts’ expectations? Or that it posted its lowest operating margin since 2017?

No and no. This isn’t to say that Microsoft stock is an elevator that can only go up. But you’ll have to find a more compelling argument than the idea that this unit which includes Office Dynamics and LinkedIn will be a long-term drag on the business. In fact, one of the reasons the business unit’s operating increased were because of an increased marketing spend for Teams (you’ve probably seen a commercial or two).

How Microsoft serves as a cautionary tale for investors

Microsoft’s stock is dropping (albeit slightly) after a solid earnings report in which growth was slowing, but was still pretty spectacular. In the past, that would send a stock soaring. However in the case of Microsoft, investors are, at best, choosing to take a little profit. And at worst, they’re looking to find another stock to “reward.”

Langley’s article gives an inkling as to why that may be. Tech stocks are behaving like safe stocks, but they’re still growth stocks. And like many growth stocks right now, some of them have elevated valuations.

Tech stocks have had at least three major selloffs in the last two years. Each time, the sector has come charging back. And that may have investors believing that any bad news is only temporary. But that may be a mistake, says Diane Jaffee, senior portfolio manager at TCW.

 “It’s like one of those Jenga games, where the ones that are at the top are the most top-heavy,” says Jaffee, “and if something changes that’s not expected, it could have it all fall down.”

The bottom line on MSFT stock

It’s easy to make the case that markets are decoupled from reality. But to believe in Microsoft’s growth is not a fairy tale. Teams will only grow in popularity. As displaced workers begin their job searches, the company should see a rebound in ad revenue from LinkedIn. And Microsoft is releasing a new version of its popular gaming console, the Xbox later this year.

That’s a lot of catalysts and that’s without including what will surely be growth in its cloud computing segment. Microsoft is a growth stock (it does, grudgingly, pay a modest dividend). And there’s a place for it in your portfolio. But base your allocation on what it is, a relatively volatile stock, and one that doesn’t always go up.