A Cheap Strategy to Play Microsoft

MSFTBill Gates is super rich but his once high-flying software company has been in the doldrums since mid-2002 after falling from the $35 level. The problem with Microsoft (MSFT) has been its failure to grow both its revenues and earnings at the superlative rates the company once enjoyed.

Any company the size of Microsoft, with a market-cap of $242 billion, will find growth an issue because of its size. But this is not to say the stock is dead. Far from it, Microsoft remains a viable long-term software company and is cash rich with $34 billion or $3.28 per share in cash. This gives the stock plenty of financial flexibility to develop or buy growth technologies. Microsoft just announced it would spend $1.1 billion in R&D at its MSN Internet unit in the FY07. And according to the Wall Street Journal, Microsoft is exploring the possibility of taking a stake in Internet media company Yahoo (YHOO) to take on Internet advertising behemoth Google (GOOG).

But with an estimated five-year earnings growth rate of a pitiful 12%, the company has its work cut out for it. Trading at 16.30x its estimated FY07 EPS of $1.44, the stock is not expensive but appears to be priced not as a growth stock.

Its PEG on the surface of 1.51 is not cheap, but if you discount in the cash of $3.28 per share, the estimated PEG falls to around 1,0, a decent valuation. Also, if Microsoft can improve on its estimated 12% growth rate, the PEG would decline further.

The fact is Microsoft at the current price deserves a look. If you want to play the stock but don抰 want to shell out the $2,347 for a 100-share block, you may want to take a look at the long-term options, also known as LEAPS. For instance, the in-the-money January 2008 $22.50 Microsoft Call LEAPS not set to expire until January 18, 2008 currently costs $380 a contract (100 shares).

This means you risk a total of $380 for the chance to participate in the potential upside of 100 shares of Microsoft over the next 20 months. The breakeven price is $26.30. If Microsoft breaks $26.30, you would begin to make money on your LEAPS. Conversely, if Microsoft fails to do anything, your maximum risk is $380 on the initial option play.

Warning: The aforementioned example is for illustrative purposes only and not to be construed as an actual option strategy. Due to the higher risk inherent in options, I recommend you speak with an investment professional before deciding to employ any strategy involving options.


Dow Turns Moderately Bearish

In trading yesterday, only the tech-laden NASDAQ avoided the selling, edging up 3.04 points to hold at above 2300 and its five-year high. As I have said, breadth in the NASDAQ has improved.

The DOW was the big loser on the day giving up 65 points or 0.58% to fall to 11,150.70, which is just below its key short-term 20-day moving average, a warning. The S&P 500 lost 2.64 points. The near-tech technical signals for these two indices are the weakest of the four indices.

Small-cap stocks continue to hold after breaking to a new historical high on Wednesday. The Russell 2000 fell 1.58 points or 0.21%, which is positive given the extreme overbought condition. The barometer of small-cap performance is up a healthy 13.28% this year. While impressive, I question whether the index can maintain this rate of appreciation.

In commodities news, the May light crude futures on the NYMEX broke above $67 a barrel on Thursday. The near-term signals look relatively bullish and the minor trend is positive. The breakout materialized after a Rectangle formation at between $61 and $65.50. Oil could move towards the $70 level, last encountered in February, if it can hold at $65.50-$66. But watch for some selling pressure as the contract is overbought. High oil prices will pressure stocks.

Trading in the NASDAQ has come in at over 2 billion shares in the last three straight sessions. Trading volume on the NASDAQ came in at about 2.22 billion shares yesterday, above its 5-day and 10-day moving averages of 2.11 billion and 2.18 billion shares, respectively. The strong volume in yesterday’s marginal up day is encouraging following a strong volume breakout on Wednesday.

On the NYSE, daily trading picked up yesterday. Trading on Thursday was 1.61 billion shares, above the 5-day and 10-day moving averages of 1.55 billion and 1.55 billion shares, respectively.

The near-term technical picture for the NASDAQ is bullish but is showing some potential weakening. The Relative Strength remains relatively strong, suggesting more gains if it can hold. The index is holding at above its previous pivot point of 2332.95 and its five-year high of 2333, a bullish sign. The index is trading at above its 20-day and 50-day moving averages of 2297 and 22854, respectively.

The MACD continues to flash a moderate buy signal. The MACD trend is negative but has reversed course. The upside break was bullish after largely trading in an intermediate term sideways channel. Now we will see if the NASDAQ can hold and edge higher towards 2366 and 2387. The index is now marginally overbought so watch for some potential selling pressure.

On the blue chip side, the near-term signs for the DOW weakened further and are now moderately bearish. The intermediate trend is bullish but yesterday’s break below its 20-day moving average of 11,156 is a warning and could signal further deterioration if it cannot hold. The Relative Strength also fell to below neutral, showing a potential lost of momentum. The MACD turned bearish yesterday and is flashing a moderate sell.

The key for the DOW is whether it can hold at around its 20-day moving average. Indications suggest further weakness, albeit the selling has created a near oversold condition. Failure to hold could drive the DOW down to 11,092, 11,077 and 50-day moving average at 11,016. A rebound could see the DOW move back to above its 20-day moving average and a pivot point at 11,234.

The Bollinger Bands on the DOW are trending upwards and widening, indicating increased volatility in the near-term. Watch this.

On the S&P 500, the near-term picture is neutral to moderately bullish. The Relative Strength weakened yesterday and is marginally above neutral. The index is trading at above its 20-day and 50-day moving averages of 1,294 and 1,283, respectively. The MACD is neutral.

Near-term targets are 1,310 and 1,333. The index needs to hold at its 20-day moving average or we could see weakness.

On the small-cap side, the Russell 2000 is bullish. The Relative Strength is relatively strong but watch if it can hold. The recent break above the previous pivot point of 745.18 was positive. The trend is positive with higher highs and lower lows.

Watch if the Russell 2000 can trend higher but given the buying, the index is extremely overbought. The MACD is positive and appears to have reversed the downtrend.

The next area of resistance for the Russell 2000 is 772 and 803.

The advance-decline line on the NYSE (0.77:1) continues to be mixed, coming in at below 1.0 yesterday. The NASDAQ (1.004:1) managed to hold at above 1.0. The daily A/D reading on the NASDAQ has been above 1.0 in 7 of the last 10 sessions. The 5-day moving average for both the NYSE (1.27:1) and NASDAQ (1.42:1) remains above 1.0.

The market is continuing to show bullish sentiment. The new high new low ratio (NHNL) for the NASDAQ came in at above the bullish 70% level for the 14th straight day, coming in at 89.35%. The NHNL ratio on the NYSE (82.69%) has been above 70% for the last 15 straight sessions.

The current technical picture for the four key indexes is as follows:

NASDAQ: Bullish; Relative Strength: Above Neutral; Marginally Overbought

DOW: Moderately Bearish; Relative Strength: Below Neutral; Near Oversold

S&P 500: Neutral to Moderately Bullish; Relative Strength: Neutral

RUSSELL 2000: Bullish; Relative Strength: Relatively Strong; Extremely Overbought

Here is what to watch for on Friday.

The DOW faces more selling pressure as its near-term technical picture is moderately bearish and the weakest of the four indices. Watch for potential support as the index is nearly oversold.

Tech and small-cap stocks continue to show the strongest technical strength but watch the extremely overbought condition in the Russell 2000 and marginally oversold condition on the NASDAQ.


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