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Will Microsoft (MSFT) Stock Disappoint in Q3 Earnings?

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Microsoft Corp MSFT is set to report third-quarter 2017 results on Apr 27. Notably, the company has mixed record of earnings surprises in the trailing four quarters, with an average surprise of 8.55%.

Last quarter, the company posted a positive earnings surprise of 5.06%. Earnings (adjusted for Windows 10 deferrals and currency effect) of 83 cents per share increased 9.2% on both year-over-year and sequential basis.

Revenues (adjusted for Windows 10 deferrals) of $26.07 billion increased 16.7% sequentially and inched up 2.2% from the year-ago quarter (up 4% in constant currency or CC). Further, it exceeded the Zacks Consensus Estimate of $21.54 billion.

Microsoft Corporation Price and EPS Surprise


Microsoft Corporation Price and EPS Surprise | Microsoft Corporation Quote

Unfavorable foreign exchange was expected to impact revenues by 1% in the third quarter. Moreover, operating expenses were anticipated to increase as investments in strategic growth opportunities continue. (Read More: Microsoft Beats on Q2 Earnings, Revenue Estimates)

Let’s see how things are shaping up for this announcement.

Factors at Play

We note that Microsoft shares have underperformed the Zacks Computer Software industry on a year-to-date basis. The stock returned 6.9%, while the industry gained 11.5%. The underperformance can be attributed to slowing Azure cloud services revenue growth, increasing competition and sluggish IT spending environment.

We note that in the second-quarter fiscal 2017, Azure revenues grew 95% at constant currency, slower than 121% growth reported in the previous quarter and 140% in second-quarter fiscal 2016.

Amazon (AMZN - Free Report) continues to dominate the cloud computing market with Amazon Web Services (AWS) trailed by Microsoft Azure. However, we believe that increasing competition from the likes of Alphabet, IBM, and Oracle will hurt Microsoft’s market share going ahead.

Moreover, sluggish IT spending is a major headwind for Microsoft. Gartner in its latest report projects IT spending to increase 1.4% over 2016 to $3.5 trillion in 2017. The figure is much lower than earlier projection of 2.7% growth.

Although estimated improvement in data center spending is good for Microsoft, slowing spending on enterprise software is a concern for Windows, Office 365 and related applications.

Meanwhile, strong PC shipment in the first quarter – as per data available from both Gartner and IDC – is positive for the company. However, intensifying competition from Alphabet’s Chromebook is a concern, in our view.

Earnings Whispers

Our proven model does not conclusively show that Microsoft will beat earnings this quarter. This is because a stock needs to have both a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) for this to happen. That is not the case here as you will see below.

Zacks ESP: Both the Most Accurate estimate and the Zacks Consensus Estimate are pegged at 69 cents. Hence, the difference is 0.00%. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Zacks Rank: Microsoft carries a Zacks Rank #4 (Sell). We caution against stocks with a Zacks Rank #4 or 5 (Sell-rated stocks) going into the earnings announcement, especially when the company is seeing negative estimate revisions.

Stocks to Consider

You could consider the following stocks with a positive Earnings ESP and a favorable Zacks Rank:

Teradyne TER, with an Earnings ESP of +2.63% and a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Seagate Technology STX, with an Earnings ESP of +3.77% and a Zacks Rank #2.

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