Since peaking last fall, Microsoft (MSFT 0.99%) shares are down more than 25%. The sell-off accelerated in 2026, as fears that generative artificial intelligence (AI) software would render Microsoft's expensive enterprise software suite obsolete led analysts to rerate how much Microsoft's current earnings are actually worth. On top of that, Microsoft's second-quarter earnings report in January showed accelerating spending on AI data centers without a corresponding acceleration in revenue from its Azure cloud computing platform.
There are certainly some well-placed concerns about Microsoft, which increase the risks for investors buying the stock today. The question investors need to ask is whether the current stock price accurately reflects the investment risk or if the market sell-off is overblown at this point and presents an incredible buying opportunity.
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The big risks facing Microsoft
While the market has sold off Microsoft stock in the last few months, analysts' outlooks for the company remain very positive. On average, analysts expect the company's earnings per share to improve by 23% over the next year. And while they see a slowdown coming in 2027, they still expect 13% earnings growth for the year.
With the stock trading at a price-to-earnings ratio of 24, this puts its price/earnings-to-growth ratio very close to 1. That's a level associated with strong buys. That means Microsoft is either a great investment opportunity right now, or a lot of analysts are about to change their outlooks for the business.
One big reason for the sell-off is disappointing Azure results. While Microsoft increased spending on capital expenditures and leases for its cloud computing platform to $37.5 billion last quarter, revenue growth remained at around the same level as previous quarters, 38% on a constant currency basis.
Management says Azure's growth was curbed by its decision to allocate more of its data center servers to its internal AI development. As a result, it didn't have as much capacity to sell to customers, and it remains capacity-constrained.
NASDAQ: MSFT
Key Data Points
However, many fear that its AI development may not be panning out as well as expected. Management shared that there are 15 million paid Copilot subscribers, which are attached to its Microsoft 365 suite. That amounts to just over 3% of its 450 million commercial customers.
The last risk investors need to consider is the concentration risk stemming from Microsoft's new contract with OpenAI. The leading AI lab signed a multi-year deal with Microsoft in October worth $250 billion. That alone accounts for 40% of Microsoft's $625 billion backlog. Considering OpenAI remains a highly risky cash-burning operation, a significant portion of that $250 billion is far from guaranteed.
The risks might not be as great as investors fear
Microsoft is one of the companies best positioned to invest heavily in artificial intelligence -- both in data centers and in research and development for its own software.
The risk of Microsoft overbuilding data centers is mitigated by its dominant position in enterprise computing with Windows and the long-term shift toward cloud computing rather than on-premises equipment. Azure is the natural choice for enterprises looking to shift their workloads to the cloud. And while that's a different workload from AI training and inference, it dramatically lowers the risk of an AI overbuild. As a result, Microsoft's capital expenditure and customer concentration shouldn't reduce its earnings multiple so much.
Additionally, few large enterprises have successfully shifted away from Microsoft's Office and Dynamics software suites, despite viable alternatives. The moat around the software business is very wide. It's more likely that Microsoft will see improved penetration of its AI services in Microsoft 365 over the next few years than that there will be a drop-off in customers. It's releasing a new enterprise software package, E7, in May, which should increase AI services adoption and revenue.
In fact, the upcoming release may be a key reason management diverted resources from Azure, as it expects to need more compute power to improve Copilot and support additional engagement. That should produce a positive return on capital over the long run if management's expectations are accurate.
I expect Azure's strong growth to continue, possibly accelerating in the back half of the year due to increased spending. Meanwhile, the high-margin productivity and business processes segment, which houses Microsoft 365 and Dynamics 365, should see some uplift from AI bundling in its new package, starting in fiscal 2027.
So, analysts' expectations don't look out of line with the business's reality, and Microsoft stock looks like a great investment opportunity.
