Microsoft's Earnings Are Already Moving the Market

The stock market had another tough day on Tuesday. Despite the huge reversal that led to positive closes on Monday for the Dow Jones Industrial Average (^DJI 0.56%), S&P 500 (^GSPC -0.88%), and Nasdaq Composite (^IXIC -2.05%), downward pressure once again asserted itself at the open on Tuesday morning. Despite a similar bounce that sent the Dow briefly into positive territory in the mid-afternoon, Wall Street wasn't able to pull a rabbit out of its hat for a second straight day.

Data source: Yahoo! Finance.

Moreover, signs are pointing to further potential weakness on Wednesday. That's because Microsoft (MSFT -1.27%) reported its latest financial results, and even though they were quite strong, they weren't strong enough to avoid a downdraft for its stock price in after-hours trading Tuesday afternoon. Let's take a closer look at what Microsoft said and why investors seem disappointed.

Image source: Getty Images.

Everything's still great with Microsoft -- except its stock

From Microsoft's nearly 5% drop in after-hours trading, you might think its fiscal second-quarter results were horrible. Yet a close look at everything the software giant said showed continued fundamental strength in its business and solid long-term prospects for the future.

Microsoft's headline numbers looked good. Revenue rose 20% year over year to $51.7 billion. Net income climbed 21% to $18.8 billion, and that worked out to earnings of $2.48 per share, up 22% from year-ago levels.

Moreover, the company saw strength nearly across the board. The intelligent cloud segment was the best performer from a revenue-growth standpoint, with a 26% rise overall. A 29% gain in server-products and cloud-services revenue was driven by Azure, with other cloud services showing revenue growth of 46%.

Meanwhile, the productivity and business-processes segment saw a 19% rise in revenue, with Office 365 Commercial seeing 19% growth and the LinkedIn business growing sales by 37%. Dynamics 365 grew sales 45%, offering another example of a cloud-related business thriving in the current environment. The "more personal computing" segment's revenue rose 15% year over year, with Windows sales to OEMs climbing 25% and search and news advertising revenue up 32%.

Microsoft also continued to do right by shareholders. The software giant spent $10.9 billion on stock repurchases and dividend payments in the quarter, up 9% from the amount of capital it returned to investors in the prior-year period.

Beaten by the law of large numbers?

Analysts looking at both the results and the subsequent stock-price drop came up with some possible explanations, the most common of which involved slowing growth rates. Yet when measured in percentage terms, reduced growth as a company expands in size is almost inevitable.

It's also clear that the COVID-19 pandemic helped to accelerate some of the trends that were favoring cloud-computing adoption among enterprise customers, and that had the effect of pulling some of Microsoft's growth forward. The assertion among analysts that investors are disappointed that those augmented growth rates proved not to be sustainable doesn't seem very realistic, but it isn't stopping some analysts from making that assertion, anyway.

In any event, Microsoft's news is hurting the entire market. An ETF tracking the Nasdaq-100 index is already down another 1.6% in after-hours trading. An S&P 500 ETF is down more than 1%, almost matching its decline in the regular trading session.

Microsoft is a big player in tech, and the idea that the behemoths of the U.S. stock market are vulnerable is bad news for investors. Rational or not, declines for big stocks could end up prolonging the entire downturn.