At its six-month lows, Microsoft (MSFT) stock has recently underperformed the S&P 500 (SPX). This underperformance has been driven by a weaker-than-expected outlook, DeepSeek’s string of AI claims, and substantial AI capital expenditures that have yet to translate into significant revenue and profit growth. The key question now is whether Microsoft can rebound from this weakness. In my view, concerns over DeepSeek, significant AI investments, and other factors are temporary, with MSFT stock perfectly positioned for re-rating over the course of 2025.
Microsoft’s long-term outlook remains strong, with the tech giant set to commercialize various initiatives in quantum computing while making tangible progress in the ongoing AI boom.
The Quantum Chip Race: Tech’s Next Big Long-Term Catalyst
Quantum computing is the latest buzzword in the tech world. According to Statista, the global quantum computing market, valued at $1.3 billion in 2024, is projected to soar to $93 billion by 2040—an astonishing compound annual growth rate of 32.9%. This immense opportunity has captured the attention of top tech companies and investors alike.
Unsurprisingly, major tech giants are urgently entering the space. Establishing a first-mover advantage could be highly beneficial, allowing companies to carve out a niche and develop a diversified revenue stream for years.
MSFT’s Quantum Leap
On February 19, Microsoft unveiled Majorana 1, its first quantum chip featuring a groundbreaking topological core architecture. The company claims that its “top conductor” leverages a novel state of matter—distinct from solids, liquids, or gases—known as a “topological state.” Designed to tackle complex, industrial-scale problems, the chip aims to provide more reliable and scalable qubits. This breakthrough is on course to boost Microsoft’s position in the rapidly growing quantum computing market.
Microsoft isn’t alone in the race. Competitors are moving swiftly: Amazon unveiled its quantum chip, Ocelot, just a week after Microsoft’s Majorana 1. Alphabet (GOOGL) launched its quantum chip, Willow, back in December 2024. Beyond quantum computing, Microsoft is also making strides in generative AI. The company recently introduced Muse, an advanced AI model designed for game development. Capable of generating diverse, high-quality AI-rendered gameplay, Muse marks a significant leap toward AI-driven game creation.
Despite these breakthroughs, quantum computing remains in its early stages, and it may take years to generate meaningful revenue and profits. In the meantime, Microsoft and its peers continue ramping up their AI investments, reinforcing their positions in the next era of computing.
Microsoft’s Weak Outlook Overshadows an Otherwise Strong Earnings Call
On January 29, Microsoft (MSFT) delivered its tenth consecutive quarter of better-than-expected earnings, surpassing analyst estimates once again. Adjusted earnings of $3.23 per share came in 11 cents above the consensus forecast of $3.12, marking a 10% year-over-year increase from $2.93. Revenue soared 12% year-over-year to $69.6 billion, exceeding expectations. However, despite a solid performance, MSFT shares declined due to a weaker-than-expected revenue outlook and concerns over a potential slowdown in Azure growth due to capacity constraints.
Microsoft’s Intelligent Cloud segment—which includes Azure, SQL Server, and Windows—delivered $25.5 billion in revenue, up 19% year-over-year. Azure and other cloud services grew 31%, slightly below the previous quarter’s 33% growth. AI services within Azure skyrocketed 157% year-over-year, driven by strong demand exceeding available capacity.
Despite these achievements, muted guidance for the forthcoming quarter dampened investor sentiment. Microsoft projected Azure revenue to grow ~30%, falling short of expectations.
Factors Behind Microsoft’s Stock Weakness
Beyond the earnings report, several external factors contributed to MSFT’s recent stock decline. A China-based startup, DeepSeek, made headlines with its latest technological breakthroughs. DeepSeek has demonstrated that large, competitive AI models can be trained for just $5.6 million using older-generation GPUs, a fraction of the cost typically associated with such projects. Further, it claimed to have created an AI model comparable to OpenAI’s GPT-4 at much lower costs.
If true, DeepSeek’s innovation could call into question the billions of dollars Big Tech is pouring into AI infrastructure. However, skepticism remains as market analysts await tangible validation of DeepSeek’s claims. Additionally, OpenAI’s February user growth reassured investors that DeepSeek will unlikely disrupt OpenAI’s momentum soon.
Microsoft’s stock took another hit after reports surfaced that the company had canceled some AI data center leases. However, this could be part of a strategic realignment rather than a retreat from AI investments. Microsoft has reaffirmed its $80 billion capex plan for FY2025, putting investor concerns to rest.
Microsoft’s Valuation Isn’t Cheap or Expensive
Despite being the third most valuable stock in the world, Microsoft’s valuation isn’t as expensive as one might think. At first glance, it may look pricey, trading at a forward P/E of 30x. However, this reflects a 5% discount from its five-year average of 31.8x. To further ease investor concerns, the tech firm tends to exceed expectations.
If we delve a little deeper, MSFT stock is more valuable now than ever, given its favorable industry-leading market position, strong margins, diversified revenue stream, and huge exposure to high-growth AI, Quantum computing, and cloud businesses. For comparison, Azure competitor Amazon, an online retail and cloud computing giant, trades at a 34x forward P/E, while Apple (AAPL) trades at a 33x forward P/E.
What is the MSFT 12-month Target Price?
Wall Street analysts continue to be bullish on Microsoft stock. The stock commands a Strong Buy consensus rating based on 28 Buys and three Holds assigned in the past three months. Microsoft stock’s average price target of $508.96 per share implies a 32% upside potential from current levels.
Tech Juggernaut Microsoft is Here to Stay
Microsoft’s recent underperformance stems from several factors, including DeepSeek’s claims of cheaper AI alternatives, a muted outlook, significant AI-related capex yet to translate into revenue and profit, and capacity constraints.
While Microsoft faces near-term headwinds from Azure growth concerns and AI investment scrutiny, its long-term fundamentals remain intact. The company continues to lead in cloud computing, AI, and quantum computing, making it a compelling investment for the long haul. Therefore, I will utilize the current stock price weakness as a buying opportunity.
Read full Disclosure