Five of the market-leading “Magnificent 7” stocks are among the more than 100 companies in the S & P 500 reporting earnings this week. We’ll review an options trade for one of those names near an all-time high that gets investors long exposure to the stock with some insurance, so they don’t feel like they are just chasing the name. The five reporting this week — Microsoft, Apple, Alphabet, Amazon, and Meta — represent more than 23% of the index by market capitalization. In total, over 41% of the index by market cap will be reporting their most recent quarterly results. The 10 companies below, based on their market capitalizations and their earnings-related implied moves are those likely to have the largest impact this week. But let’s focus on Microsoft (MSFT) . Breaking down MSFT fundamentals Microsoft is one of the most important technology companies in the world. As of this writing, it is the only publicly traded company in the world with a market capitalization exceeding $3 trillion, a number so large it is hard to get our head around, but consider this: The company’s market capitalization is 50% larger than Saudi Arabian Oil Company, aka “ARAMCO” which represents 14% of global oil production. Windows, the company’s most familiar software product, is the dominant desktop computer operating system (OS) with greater than 70% market share. While Windows may be the most familiar Microsoft product, it is not their largest source of revenue, trailing cloud services. Although Microsoft has continued to see stellar revenue growth, far exceeding the growth in the economy overall, it has slowed slightly over the past years, averaging 7.5% year-over-year over the past 4 reported quarters vs. an average growth rate of 16.4% over the prior 12 reported quarters between 2019 and 2022. Net Income has been a bit lumpier, averaging 11% growth year-over-year in the past 4 reported quarters vs 20.5% over the prior 3 years. This is important because investors are willing to pay a higher multiple for faster growing companies. MSFT valuation Earnings that surprise to the upside lead investors to pay a bigger turn on a larger number. Over the past five years, Microsoft’s price-to-earnings ratio has been as low as 25.8 and as high as 41. Microsoft hit a new high on January 25th and is currently up more than 7.4% for the year. Buying a stock close to all-time highs is a bit nerve-wracking. So much good news is already “baked in” to the stock price. What are the future sources of earnings growth? Assuming the company can return to higher rates of revenue growth, it must also maintain or grow profit margins. On this metric, Microsoft has been quite consistent over the years, averaging 35%. The 8% headcount reduction the company announced last week in their gaming division was likely needed as the company eliminated some redundancy after the acquisition of Activision Blizzard was finalized in October of last year. Microsoft sales are driven primarily by corporate IT spending. If the most recent economic data is to be believed, IT infrastructure spending may be higher than many analysts may have been anticipating. Azure will continue to grow as the cloud computing tailwind continues. The biggest buzz, of course, is the potential contribution of generative artificial intelligence. Microsoft is, ultimately, a company focused on productivity and business process support, and generative AI is likely the next step to change as the alliance with OpenAI strengthens (recall that OpenAI CEO Sam Altman was fired from the company, but quickly returned in large part because of the support of Microsoft CEO Satya Nadella). Some are anticipating organic sales growth of 15%, double the 7.5% average the company experienced over the past 4 quarters. The trade I get that chasing a stock already up over 7% for the year, and more than 60% over the past 52 weeks is nerve-wracking. So instead consider purchasing a call spread for $12.50 ($1,250 as each contract represents 100 shares), an outlay of 3% per share. The trade: Bought April $410 call Sold April $450 call Generally, technical resistance occurs at a prior high, in this case, $407, if we assume we want to participate if it breaks out above that level we could purchase the April $410 calls for $16.50 and sell the April $450 calls at $4 against it, thus spending $12.50 in premium. Right now the options market is implying a move of 4.3% higher or lower the day after the company reports, the upside breakeven for the call spread is 4.5% above the current stock price, but it expires on April 19th. DISCLOSURES: (Long MSFT) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
