Investors have some big questions heading into the fiscal third-quarter earnings report from Microsoft (MSFT 0.11%). The software giant's last update showed a demand slowdown spreading into several of its key niches, including cloud services.

But in late January, management sounded an optimistic tone about Microsoft's long-term potential in areas like cybersecurity, video games, productivity software, and artificial intelligence (AI).

Let's take a closer look at Wall Street's expectations for the April 25 report, and what the announcement might mean for Microsoft's stock returns in 2023.

There are questions about the demand

Most Wall Street pros are looking for sales to rise by just 3% in the third quarter, which runs through late March. That result would mark an improvement over the prior quarter's 2% uptick, but the bigger question is whether demand trends are still deteriorating.

Executives said in a January conference call that demand weakness was spreading into previously high-growth areas like its commercial software business, the Azure platform, and the U.S. market in general.

"We are seeing customers exercise caution in this environment, and we saw results weaken through December," chief financial officer Amy Hood told investors. We'll learn in a few days to what extent those negative trends worsened into calendar year 2023.

Profits and cash flow

Microsoft's stock price movement will also depend on how well management can strike a balance between profitability and investing in growth initiatives. Even in a cyclical downturn, as has already started in niches like PC software, the company aims to keep winning market share while it cuts costs and boosts efficiency.

MSFT Operating Margin (TTM) Chart

MSFT operating margin (TTM) data by YCharts. TTM = trailing 12 months.

Look for progress here showing up in metrics like operating profit margin. This figure declined in late 2022 but remained elevated compared to pre-pandemic days. Through late December, Microsoft generated $22 billion of adjusted operating income, translating into a margin of more than 40% of sales. Cost cuts should help protect this industry-leading figure in 2023.

Watch for solid cash flow, too, which is helping fund direct shareholder returns through dividends and stock buybacks. Microsoft spent $9.7 billion in these areas last quarter.

Outlook and value

Heading into the report, most investors expect sales trends to keep accelerating modestly in 2023, mainly thanks to easing currency-exchange pressures. Earnings are projected to rise at a slightly faster rate than sales, too, thanks to Microsoft's aggressive cost-cutting efforts.

The stock's short-term movement will depend on how well management's fiscal fourth-quarter forecast fits with that broader investment thesis. If Microsoft sees even more caution from customers, especially in its commercial and cloud services, then the stock could easily give back some of the market-beating gains that shareholders have seen since the start of the year.

The company's medium-term growth outlook seems bright, though, even if the next few quarters show spotty results across its core markets. And Microsoft remains highly profitable and flush with cash. These factors suggest the stock could continue beating the market over the next year.

Risk-averse investors might want to wait for more clarity following the upcoming earnings report. But Microsoft seems primed for another year of steady market share gains in several attractive tech niches in 2023.