The market's perception that Microsoft (MSFT 1.11%) has fallen behind in artificial intelligence (AI) continues to weigh on the stock. The criticism isn't unwarranted.
Microsoft Copilot simply hasn't become a top AI app for enterprises. That's certainly disappointing, and the company's soaring AI spending hasn't helped matters.
Microsoft's slide has brought the stock down to 23.5 times trailing 12-month earnings, a level investors seldom get the chance to buy at. Cheap isn't always a buying opportunity. But in Microsoft's case, it's hard to ignore the stock here.
Growth supports the stock's valuation
Just because Copilot hasn't kept up with ChatGPT or Claude doesn't undo the deeply entrenched relationships Microsoft enjoys across the enterprise world.
Microsoft still rakes in high-margin sales hand over fist on its various software products, including Windows, Microsoft 365, Dynamics, and more. Its cloud services arm, Azure, is also thriving. Cloud revenue grew 29% in the third quarter of its fiscal year 2026, and Azure's commercial RPOs (remaining performance obligations) surged 99% to $627 billion.
Image source: The Motley Fool.
In other words, Copilot's failure thus far isn't dragging the ship down. Analysts estimate that Microsoft will grow its earnings by an average of 17% annually over the next three to five years. That growth rate would make any stock a table-pounding buy at 23 times earnings, let alone the tech empire and world-class company that is Microsoft.
Just how bad is the hyperscaler cash flow problem?
As a top AI hyperscaler, Microsoft is pouring billions of dollars into data centers and other AI infrastructure. Microsoft is a financial juggernaut that generates more cash from its operations almost every year, including a staggering $170 billion over the past 12 months. But even the deepest pockets have limits. Microsoft might soon find itself with little or no free cash flow, considering its plans to spend $190 billion this calendar year.
NASDAQ: MSFT
Key Data Points
It's not an existential crisis by any means, as Microsoft has a fortress-like balance sheet it can tap if it chooses to continue on this path. It does make Microsoft a capital-intensive company for the time being. That reality is a major reason why the stock has struggled. So, should all this AI spending dissuade investors from buying Microsoft stock?
Here's how I look at it. If AI is the real deal and Microsoft and other hyperscalers can successfully monetize all of this infrastructure, it will likely drive robust earnings growth for the foreseeable future. These companies are laying the groundwork for a world where AI is a core economic engine. If it's the opposite, say AI is some temporary blip, then Microsoft can still turn off the spigot, and all the cash flow its existing businesses generate will suddenly gush back to the financials as free cash flow.
Either way, I like Microsoft's chances of continuing to earn higher profits years into the future.
