Microsoft shares surged on Monday after a positive report and upgrade from Wells Fargo. The firm did that even though it also cut its earnings per share estimates for the software giant. Also the upgrade flies in the face of a recent rash of price target cuts from other firms.

Microsoft Corporation Upgraded, Multiple Expansion Expected

Microsoft moves to Outperform

In a report dated April 6, analyst Jason Maynard and his team said they have upgraded Microsoft stock from Market Perform to Outperform. They like the direction in which management is taking the company as they focus on the cloud and mobility. Their target price remains the same at a range of $46 to $50 per share.

Nonetheless, they think consensus estimates for Microsoft’s upcoming earnings reports must come down. As a result, they have cut their total revenue estimate from $21 billion to $20.7 billion for the third fiscal quarter. They also trimmed their earnings per share estimate from 53 cents to 52 cents per share. Their June quarter estimates also fall, declining from $22.7 billion to $22 billion for revenue and from 61 cents to 60 cents per share in earnings.

For the full year, Wells Fargo is now estimating earnings of $2.50 per share, compared to their previous estimate of $2.52. For fiscal 2016, they’re estimating $2.70 per share, compared to their previous estimate of $2.73 per share.

Why Wells Fargo upgraded Microsoft

The Wells Fargo team thinks Microsoft’s current share price “adequately reflect” the hangover from Windows XP and also the headwinds caused by the strengthening of the U.S. dollar. They also think Microsoft’s share price already assumes that there will be one more round of reductions in earnings per share estimates.

The stock has declined by more than 12% already this year, underperforming the S&P 500, which is just about flat from where it was at the beginning of the year. The Wells Fargo team notes also that the majority of the stock move from the XP overhang has been erased.

Microsoft management moving in the right direction

The analysts also think Microsoft management is making the right decisions, moving the company in the right direction in the medium to long term. They think the company’s strategic positioning is better thanks to its new products for the cloud and mobile. They also like the cross-platform strategy, which based on a “software anywhere” approach.

The Wells Fargo team does admit that there is a risk to their upgrade, which is that they assume Wall Street is already assuming that there will be downward revisions to analyst estimates for Microsoft. However, they don’t think the downside risk to Microsoft shares is much more than 5%. At the midpoint of their valuation, there’s a 15% upside potential, which is why they find the risk / reward profile for Microsoft shares “compelling.”

As of this writing, shares of Microsoft were down 0.18% to $41.47 per share.

Tags: