It has been a frustrating start to 2026 for Microsoft (MSFT 2.44%) investors. Year to date, the stock has fallen about 18%. Even worse, the stock is down about 29% from a 52-week high of $555.45.
The tech stock's decline comes as many software stocks take a beating amid investor caution over evolving risks in an era of artificial intelligence (AI).
Previously, I viewed this pullback as a potential opportunity. After all, the underlying business continues to do very well. In its fiscal Q2, for instance, Microsoft's revenue rose 17% year over year, and operating income rose 21% to $38.3 billion.
But after thinking more about the competitive landscape and the details of Microsoft's recent earnings report, I've changed my mind. I now believe the risk of further multiple compression is greater than I previously anticipated. That said, AI is only part of the threat I'm concerned about. My bigger concern is the wide range of ways Microsoft's business could be flanked from all sides in the coming years.
Image source: Getty Images.
About that backlog
On the surface, demand for Microsoft's AI-capable cloud computing looks virtually unstoppable.
In its fiscal second quarter, Microsoft said its commercial remaining performance obligations (RPOs) rose 110% year over year to $625 billion. This metric, which represents the dollar value of contracted commercial work not yet recognized as revenue, is a key indicator of demand.
But there are glaring risks hidden in this massive number.
First, a huge portion -- 45% to be exact -- of Microsoft's commercial backlog comes from a single customer: OpenAI. When you strip out OpenAI, Microsoft's commercial RPOs are growing much slower, at a rate of 28% year over year.
Second, this backlog will take substantial time to convert into actual revenue. Microsoft said only 25% of its total commercial RPOs are expected to be recognized in the next 12 months.
Further, despite the surging backlog, Microsoft's "Azure and other cloud services" revenue actually decelerated in fiscal Q2, growing 38% year over year in constant currency, down from 39% the prior quarter.
This deceleration is occurring while Microsoft's capital expenditures are soaring, reaching $37.5 billion in fiscal Q2 -- up 66% year over year.
The company is spending aggressively to support this backlog, but relying so heavily on one partner for future contracted revenue while cloud growth decelerates is a tough setup for investors to buy into.
Shifting moats and fierce competition
Beyond the backlog, Microsoft faces intensifying pressure from its big-tech peers.
Amazon (AMZN 3.89%) remains the clear leader in cloud computing, and its Amazon Web Services (AWS) segment is seeing accelerating momentum. Amazon's fourth-quarter AWS revenue rose 24% year over year to $35.6 billion. This was up from 20% year-over-year AWS revenue growth in Q3.
Meanwhile, Alphabet's (GOOG 2.49%)(GOOGL 2.30%) Google Cloud is growing even faster. In its fourth quarter, Alphabet's cloud computing business saw revenue soar 48% year over year.
And while this potential threat is more speculative, the biggest long-term threat to Microsoft might be a demographic shift in the enterprise sector.
Microsoft has long relied on its entrenched enterprise usage as its primary moat. But what will happen when a generation that grew up on Google products comes into more executive roles over time? Alphabet already dominates search and boasts massive market share with its own productivity suite, including Google Docs, Google Sheets, and Google Slides. Alphabet's Google Chrome and Gmail also command more market share than Microsoft's Edge and Outlook, respectively.
Then, of course, there's the growing popularity of Alphabet's generative AI, Gemini.
My revised take on Microsoft stock
At a price-to-earnings ratio of about 25 as of this writing, Microsoft's valuation doesn't look very expensive on the surface.
But a valuation like this still requires the company to maintain its competitive moat, successfully monetize its massive AI capital expenditures, and maintain its lucrative profit margin in its software business.
If Microsoft loses enterprise market share to Alphabet, or if the economics of its OpenAI-heavy backlog prove poor and weigh on margins, the stock could face a meaningful rerating.
Microsoft is undoubtedly a spectacular business. But the tech landscape is shifting rapidly. At a time when tech giants are spending aggressively, Microsoft is at risk of losing its competitive advantage and, in turn, losing some of its pricing power.
My new take on the stock? Don't buy the dip.
If the stock fell to a level that gave it a price-to-earnings ratio of around 18 to 20, I might reconsider my stance.
