Microsoft’s (NASDAQ:) stock price plunged more than 6% following its FQ2 earnings report and broke the uptrend, but it doesn’t matter. The results were strong, and the long-term opportunity offsets the weak guidance. The critical detail in the report is the accelerating growth of AI services.
The acceleration underpinned its cloud segment even as Azure’s growth slowed and affirmed the long-term AI outlook. That includes a services boom that is bigger and longer-lasting than the infrastructure boom underway. The forecast for AI services industry growth is robust and continues to rise, expecting a 36% CAGR over the next seven years or longer.
Microsoft Outperforms in Q2: Guidance Is Weak But Relative to a High Bar
Microsoft had a solid quarter, producing a double-digit revenue growth and a substantial margin. The company’s $69.6 billion net revenue is up more than 12% compared to last year on strength in all significant segments. Regarding products versus services, product sales fell 14% and were offset by a robust 22% increase in services. More Personal Computing is the only weak spot on a segment basis, and its business is flat. Productivity and Business Processes grew by 14%, led by a 19% increase in Intelligent Computing. IC gains were driven by a 21% increase in Microsoft Cloud revenue, including a substantial 31% increase in Azure.
The margin news is also strong, including improved gross and operating results. Operating income grew by a leveraged 17%, leaving GAAP earnings at $3.23 or $0.13 above MarketBeat’s reported consensus. GAAP earnings are up only 10% compared to the 12.2% top-line advance, but they are impacted by increased investment expected to sustain growth long-term. Investment plans include a 50% annual data center spending increase to strengthen the company’s cloud position and foster the AI services business.
The guidance news is why the stock price fell. The company reiterated its previously stated outlook, adding the impact of new FX headwinds. Microsoft expects currency conversion to cut about 2% off the top line and impact the margin. The takeaway, however, is that FQ3 results include another quarter of double-digit top-line growth, strong margin, and substantial cash flow despite increased investment. Cash flow in Q2 was sufficient to sustain the capital return outlook and drive balance sheet improvements, including reduced debt, total liability, and a 12.75% increase in shareholder equity.
Analyst Sentiment Remains Firm: Microsoft to Hit $500
The analysts’ positive response to Microsoft’s results and guidance update will help support its stock price over time. MarketBeat tracked a single price target reduction offset by numerous reiterated ratings and targets. They, including the price target reduction, peg the stock at Moderate Buy and forecast a move to the $500 level or higher by year’s end, aligning with the broader trends. The broader analysts’ trends include increasing coverage and a price target that is up 20% in 12 months, indicating a 25% stock price increase in 2025.
Microsoft’s valuation is a concern but offset by the long-term outlook. Its 34x earnings multiple aligns with the most successful tech companies today, which are a highly-valued group, but it is more than a 50% premium to the with slowing growth in the forecast. However, despite the slowing, revenue is expected to sustain a low-double-digit CAGR through 2025, and earnings to grow slightly faster. In this scenario, the company’s price multiple falls below the broad market average by 2030, suggesting a value relative to the outlook.
The technical action following the release is concerning, but a primary trend line was broken. The break in trend could lead to a reversal in the action, but in this case, a deep decline is unlikely. The more likely scenario is that Microsoft’s price trend switched from up to sideways and will continue to move within the established range.
The low end of the range is near $400, and the high is near $460. The bias is to the upside, but it may take a quarter or two before the next uptrend begins and a new high is set. 
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