Microsoft: A Powerful Indicator Says To Buy The Stock

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The recent selloff in tech stocks has been a long time coming, or a great buying opportunity, depending upon how you view the run-up that led to today. I’m not here to debate whether tech stocks were – or still are – in a bubble, but what I am here to do is provide some clues as to when may be a good time to take a long position on one of the market’s largest stocks, Microsoft (MSFT).

Microsoft has seen a huge run this year, just like many other tech stocks. Microsoft’s has been smaller in magnitude than some, but impressive nonetheless, as it managed to climb from $132 in March to $232 a couple of weeks ago.

Since that all-time high, Microsoft sold off sharply with the rest of the group, and sits today just over $200. This sort of price action begs the question; if you want to buy Microsoft, is it attractively priced after the sharp move lower? Based upon the evidence, I believe it is.

Microsoft has outperformed the broader market this year by more than 25%, which is impressive, particularly for a company as large as this one. Unfortunately, the company has only kept pace with its peer group – software stocks. Microsoft came out of the gate hot against its peers but has gradually faded as the year has worn on. As a long-term market leader, I believe this underperformance relative to its peers will cease and turn higher. This is particularly true if a period of general weakness befalls the market; faster-growing software stocks – of which there are many – have run higher more quickly than Microsoft. However, Microsoft’s stability and size will prevail in a scenario that isn’t seeing investors chasing the stocks with the highest growth rates.

Using data to guide your purchases

I’m a big believer that human emotions are highly flawed when it comes to investing. I learned the hard way (many times) that investing based upon emotion is a recipe for disaster. Falling in love with a stock (or perma-hating a stock) is a great way to watch your capital erode away. I’m not a fan of that, so I try to use data wherever possible to save me from myself.

There are innumerable data points one can use to make investing decisions. I’m focused on price-related data because that requires no one’s opinion, and reflects true market activity that takes into account all known information about a security. This is as close as we can get to infallible data in investing.

One way that I like to measure if a stock is cheap or expensive relative to recent price action is by using rolling returns for different periods. This is essentially just a total price return number for whatever number of days, which helps smooth out the day-to-day fluctuations of a stock’s movement, and more easily spot value or extended prices.

This indicator isn’t perfect, as nothing is, but I have found it to work quite well for market-leading stocks, among which I’d certainly count Microsoft.

We’ll begin with a rather short time frame of 10 days, which you can see below.

Source: Author’s calculations using historical price data

The first thing I notice about this chart is how few times Microsoft strikes the zero mark. Indeed, for all of this year, we have 10 such events (if we count oscillations of multiple days around zero as one event). In nearly nine months of trading activity, that’s not a huge sample set. That must mean the indicator is pretty significant when it does get triggered, and that is exactly why I use it.

We can see that the prior instances of 10-day returns reaching or piercing below the zero mark were quite good in terms of buying opportunities, as the stock moved meaningfully higher after each strike, even if it took a week or two. Sometimes, the stock bounces right off the line and moves higher. Either way, it has been a good indication that it could be time to buy.

Interestingly, the indicator is at the lowest level it’s been at since the pandemic panic earlier this year. After a period of sharp gains led to 10-day returns in excess of $20, we’ve seen exactly the opposite behavior, and it looks to me like Microsoft is very oversold on a 10-day basis.

But what about the longer time frames? Below, I’ve plotted the same metric, but for 30 days instead of 10. This covers about a month and a half of trading activity, so it moves much more slowly than the 10-day. This results in fewer buy signals, but much more important ones when they do trigger.

Source: Author’s calculations using historical price data

As we can see, 30-day returns have hit zero only a couple of times this year, much fewer than the shorter time frame we looked at above. This makes logical sense, and it means that now, Microsoft is seeing a buy signal we’ve only seen two times so far in 2020. Those instances were at the start of the pandemic panic and about a month ago, prior to its run to all-time highs.

Final thoughts

I’ll reiterate again that no indicator is perfect, and this one isn’t either. I cannot say with certainty that Microsoft will begin rallying from here, and anyone that tells you they can say that is mistaken.

However, the combination of the 30-day signal and the very oversold 10-day indicator occurring at the same time is extremely attractive in my view. If you want to own Microsoft, history would suggest that now is a terrific time to buy. We have our short-term indicator at very oversold levels and our medium-term indicator hitting a strong buy signal simultaneously We should see the stock bounce from here in the coming weeks, and for that reason, I’m bullish.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MSFT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.