Microsoft (MSFT) saw a notable decline in its market cap over the past month (down 13.5%). Weaker-than-expected cloud results overshadowed Microsoft’s earnings performance, which met overall expectations. Despite the recent sell-off, Microsoft remains attractive for the longer term, driven by its well-diversified business portfolio, continuing AI investments, and ongoing initiatives to capitalize on Azure growth in the coming years. Therefore, I believe patience is key and will view any dip as an opportunity to buy Microsoft shares.
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Microsoft’s Upbeat Results Didn’t Impress Due to Cloud Weakness
On July 30, Microsoft reported better-than-expected Fiscal Q4 results for the eighth consecutive quarter. Q4 adjusted earnings of $2.95 per share were a cent ahead of analysts’ estimates of $2.94 per share. Also, earnings jumped 9.7% year-over-year compared to earnings of $2.69 per share in the prior-year period. Further, revenues soared 15% year-over-year to $64.7 billion.
Despite beating overall expectations, investors were left disappointed, as cloud revenue growth fell short of analysts’ expectations. The Intelligent Cloud business segment, encompassing Azure Cloud, SQL Server, and Windows, among others, witnessed an increase of 19% year-over-year to $28.5 billion, lagging expectations. Further, this came in lower than the previous quarter’s growth of 23%.
With AI at the helm of the revenue growth story, there is substantial excitement for Microsoft’s Azure and related cloud services. Disappointingly, however, Azure and other cloud services experienced slower-than-expected revenue growth of 29%, lagging behind Wall Street’s expectations and the previous quarter’s growth of 31%.
Azure’s slower growth was attributed to weakness in Europe and ongoing capacity constraints. These constraints are expected to continue in the first half of the coming year. However, they are expected to improve in the second half.
Further adding to investors’ dismay, Microsoft provided a muted outlook, slightly below expectations. Fiscal Q1 Azure revenues are expected to grow between 28% and 29% in constant currency (down from 30% – 31% guidance for the currently reported Q4).
On a positive note, Microsoft projects faster growth in Azure during the second half of Fiscal Year 2025. Further, Microsoft anticipates double-digit revenue growth during FY2025, which is reassuring of the company’s sustained growth trajectory.
Long-Term AI Growth Potential Remains Intact
Microsoft’s strategy has made it one of the AI leaders in the world. Right from its timely partnership with OpenAI’s ChatGPT to its increasing capital investments in AI, Microsoft has reaped the benefits, making it the most valuable company in the world.
AI investments have been instrumental in driving revenue growth across diverse revenue segments and products, including Azure, GitHub, Copilot, and Office suites, to name a few. Although Azure remains second to the industry leader Amazon’s (AMZN) AWS, AI has significantly assisted Azure in quickly gaining market share from both AWS and Google’s (GOOGL) (GOOG) Cloud.
Specifically, market share gains for Azure have been remarkable. Azure now holds a 25% share of the Cloud industry versus approximately 19% three years ago. Notably, over the same period, AWS’s share has remained at around 31%, while Google has been in the 7% to 10% range, according to Statista.
From the Q4 earnings, the main cause of concern for investors was the deceleration in revenues at Azure despite a significant ramp-up in capital investments to $19 billion reported during Q4 (up from $14 billion in the preceding quarter and $10.7 billion during the prior-year quarter).
Markedly, not just Microsoft but most of its top-tech rivals like Google and Meta Platforms (META) are heavily investing in AI-related technology, products, and data centers to stay ahead in the AI marathon. For instance, Google reported CapEx (capital expenditures) of $13 billion in the recently ended second quarter (Q1 was $12 billion).
Capital investments in AI may take longer to manifest in real numbers as a direct catalyst to revenues. Sooner or later, however, these investments are bound to boost revenues. Most likely, the revenue benefits will start showing in the second half of FY2025 with expected Azure reacceleration.
What helped alleviate investors’ concerns were CFO Amy Hood’s comments. She reaffirmed that Azure continues to gain market share at an accelerated pace driven by AI. Further, she stated that “Azure growth included 8 points from AI services where demand remained higher than our available capacity.” Further, she mentioned that most of the CapEx was directed toward “Cloud and AI-related spend.”
Microsoft’s Valuation Isn’t Cheap but Isn’t Expensive Either
Despite being the most valuable stock in the world, Microsoft’s valuation isn’t as expensive as one might think. At first glance, it may look expensive, trading at a forward P/E of 30x. Nonetheless, I believe the premium is justified, given its favorable industry-leading market position, strong margins, diversified revenue stream, and huge exposure to high-growth AI and cloud businesses.
For comparison, Azure’s competitor, and online retail & cloud computing giant Amazon is trading at a P/E of 34.3x, while Apple Inc. (AAPL) is trading at a 31.5x forward P/E.
Is Microsoft Stock a Buy, According to Analysts?
Wall Street analysts continue to be bullish on Microsoft stock, despite some lowering their price targets after the earnings report. Overall, the stock commands a Strong Buy consensus rating based on 32 unanimous Buys assigned in the past three months. Microsoft stock’s average price target of $503.19 implies 25% upside potential from current levels.
Conclusion: Consider Buying MSFT for Its Long-Term Growth
Microsoft’s early investments in AI have positioned it as a frontrunner in the industry, yielding significant rewards. Despite the near-term weakness, Azure growth will likely reaccelerate in the second half of Fiscal 2025. In the longer term, Azure’s growth, spurred by AI innovations, will continue to act as a strong catalyst for Microsoft’s revenues and profitability.
MSFT stock may remain range-bound in the near term until the AI investments begin to reflect in the numbers. Until then, I will view any dips as opportunities to buy Microsoft shares.
