Source: PaxForex Premium Analytics Portal, Fundamental Insight
Microsoft stock tumbled yesterday after the software giant updated its financial outlook for its fiscal Q4 ending June 30. The tech pioneer said it will have to lower its expectations for the quarter, a reason that could become much more common when the reporting season begins in July.
Microsoft justified its warning with changes in exchange rates between the beginning of the quarter and the end of May. Specifically, as the U.S. dollar has strengthened against major foreign currencies, companies that do significant business overseas face a difficult choice: either raise prices in international markets or suffer a decline in dollar revenues and profits. Microsoft chose the latter path, and investors need to consider the implications not just for the software company, but for every business in a similar situation.
When Microsoft first gave its forecast for the current quarter in early May, it already assumed that foreign exchange would have a negative impact. At the time, the company projected that the strong dollar would reduce overall revenue growth by two percentage points, with similar declines in the smart cloud and personal computer segments. Microsoft had expected a larger revenue decline of 3 percentage points in the productivity and business process segments.
However, the update showed an even larger decline than expected. Microsoft expects total revenue to be about $460 million worse than previously expected, setting the new forecast at $51.94 billion to $52.74 billion. That means a decline of almost one percentage point, with the productivity and business process segment taking the biggest hit.
Microsoft will get some benefit from the fact that some of its expenses are also denominated in weaker foreign currencies. However, the company lowered its net income projections by $250 million and now expects between $16.85 billion and $17.43 billion.
In terms of raw numbers, these reductions in the top and bottom lines of earnings seem substantial. However, while investors shouldn't completely ignore them, it's important to put them in perspective.
First, the resulting decline in Microsoft earnings should be relatively small. The company was expecting a $0.03 per share decline in earnings because of exchange rate differences, setting the new guidance at $2.24 to $2.32 per share. That's just over 1%.
Moreover, Microsoft is not at a competitive disadvantage over its U.S. competitors because of the currency issue. On the cloud computing front, for example, both Amazon and Alphabet will face similar problems with their foreign customers. Foreign competitors will have a potential advantage, but currency rates tend to fluctuate up and down over time in ways that level out over business cycles.
Nevertheless, investors need to understand that currency exchange is an issue that can affect a company's performance across the economy. Shares of technology companies are far from the only ones that could be affected by a strong dollar. Multinational consumer goods companies may face even greater problems because rising inflation has a more direct impact on the cost of materials and ingredients than it does on software development. Because many of these consumer stocks are seen as more protective investments, any subsequent decline in stock prices could further worsen overall investor sentiment about the stock market as a whole.
Microsoft's currency problems are unfortunate, but they will not change the bullish sentiment about the company's stock. The cloud-based business model that CEO Satya Nadella helped bring to life should continue to drive growth in the coming years. Investors may have to get used to the currency headwinds for a while, but the gradual decline in key metrics should pale in comparison to Microsoft's ability to expand its leadership role in technology.
As long as the price is above the 263.00 level, follow the recommendations below:
- Time frame: D1
- Recommendation: long position
- Entry point: 274.42
- Take Profit 1: 290.00
- Take Profit 2: 302.00
Alternative scenario:
If the level of 263.00 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation: short position
- Entry point: 263.00
- Take Profit 1: 252.50
- Take Profit 2: 246.00
