For shareholders of Microsoft (MSFT), this is hardly a pleasant time. The software and cloud computing giant’s stock tumbled nearly 7% in last week’s broad market sell-off. As of the time of reporting, the tech stock has accumulated a decline of more than 26% so far this year.
On the surface, Microsoft has just delivered an impressive quarterly earnings report. In the second fiscal quarter ended December 31, Microsoft’s revenue increased 17% year-over-year to $81.3 billion. Its earnings performance was even more striking: non-GAAP (adjusted) earnings per share jumped 24% to $4.14. The primary growth engine remained the cloud business, with Microsoft Cloud revenue rising 26% year-over-year to $51.5 billion, of which “Azure and other cloud services” revenue (the company’s cloud computing business) climbed 39%. Additionally, commercial remaining performance obligations (a metric for contracted but not yet recognized revenue) surged 110% year-over-year to $625 billion. For investors seeking buying opportunities, such a sharp stock decline might seem like an unmissable bargain.
However, the revenue growth rate for Microsoft Azure and other cloud services slowed from 40% in the previous quarter. During a critical period of AI infrastructure investment, Google Cloud’s growth significantly outpaced Microsoft’s cloud business, indicating intensifying competition in this important new arena.
Beyond the cloud infrastructure battle, another structural risk looms over Microsoft: the potential disruption of traditional software models by artificial intelligence. Microsoft’s Productivity and Business Processes segment (which includes Office products) contributed $34.1 billion in revenue in the second fiscal quarter, and with Microsoft 365 boasting over 450 million commercial seats, the company is heavily reliant on a software subscription model. But as AI capabilities grow, the nature of software is changing. The rise of “agentic AI systems” capable of autonomously planning and executing complex workflows could ultimately reduce the amount of human labor required for certain tasks. If companies need fewer knowledge workers in the future, demand for Microsoft 365 commercial seats will correspondingly decline. While Microsoft’s AI tools like Copilot offer short-term monetization opportunities, in the long run, AI may exert deflationary pressure on the seat-based software subscription model. More concerning is that AI could intensify overall competition, erode software pricing power, and ultimately compress profit margins and software profits.
As of the time of reporting, Microsoft’s stock price is approximately $357, with a price-to-earnings ratio of around 22 times. Relative to historical valuation levels, this might seem like an attractive entry point. However, current valuations are reasonable or potentially even low. The company is under triple pressure: soaring capital expenditures, intensified cloud competition from Alphabet, and the unknown long-term risks that AI poses to its core software subscription business. Moreover, these AI-driven uncertainties could persist for years. Overall, investors should consider staying on the sidelines and waiting for an even greater discount before buying.
