Microsoft (NASDAQ:MSFT) stock fell over 9% on Jan. 27, despite matching analyst estimates on earnings and topping them on revenue for its second quarter. The tech giant's earnings slipped 9% year-over-year to $0.71, but revenue rose 8% to $26.47 billion.

However, Microsoft lowered the midpoint of its guidance for the current quarter to $21 billion, which was $3 billion lower than analyst expectations. The company attributed that to slower PC sales and a transition toward cloud-based data centers. That soft guidance prompted a flurry of downgrades on the stock.

But now that Microsoft stock has fallen to a three-month low, should value investors consider buying shares? Could the stock slip further before it bounces back?

First, the bad news...
The nastiest spot on Microsoft's earnings report was a 13% year-over-year decline in both Windows OEM Pro and non-Pro revenue.

That decline wasn't surprising, since the company has been slashing Windows license fees to gain users. Last year, it eliminated the license free for Windows Phones and tablets under 9 inches, and launched a low-cost version of Windows (Windows 8.1 with Bing) to help OEMs compete against Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Chromebooks.

Sacrificing short-term revenue to boost Windows market share paves the way for the introduction of Windows 10, which will be a free upgrade for Windows 7 and 8 users within the first year. This could help Microsoft finally consolidate nearly 70% of the fragmented PC market. With Windows 10 installed on more PCs, Microsoft can then advance its newer cloud and productivity initiatives like "universal apps," OneDrive, Office 365, Dynamics CRM, and Azure.

Therefore, a double-digit drop in Windows revenue shouldn't alarm investors -- it's merely a part of Microsoft's transition.

Now, the good news...
On the bright side, Surface sales rose 24% year-over-year to $1.1 billion, fueled by strong demand for the Surface Pro 3 and its accessories. This indicates that businesses and consumers still need 2-in-1 devices to bridge the compatibility gap between older PCs and newer tablets.

Microsoft's Surface Pro 3. Source: Microsoft.

Windows Phone revenue dipped 11% sequentially to $2.3 billion, but unit sales rose 13% to 10.5 million, indicating that Lumia handsets are gaining ground in the low-end market. This means that fears of cheap Android handsets wiping out Windows Phones might be overblown. Windows Phones also might become more appealing after being upgraded to Windows 10, which will tether them to a "One Windows" ecosystem shared by PCs, tablets, and the Xbox One. Xbox sales (Microsoft reports 360 and One sales together) climbed sequentially from 2.4 million to 6.6 million units, thanks to strong holiday sales.

Commercial cloud revenue -- driven by Office 365, Azure, and Dynamics CRM -- rose 114% year-over-year, compared to 128% growth last quarter, and is now on an annualized run rate of $5.5 billion. That would represent less than 6% of Microsoft's expected revenue of $98 billion for fiscal 2015, but the segment's triple-digit growth is a confirmation that its renewed focus on the cloud is paying off.

Bargain or bull trap?
In my opinion, Microsoft is a fundamentally sound company which is in the middle of a costly, albeit necessary, transition.

Windows revenue will likely decline in the near term as Microsoft values user growth over license fees, but that shift will eliminate its dependence on inconsistent OS upgrades while boosting the importance of cloud-based software and services. That shift will also defend its operating systems and productivity software against Google's free alternatives.

However, Microsoft's current valuations indicate that the stock doesn't have much upside potential. Over the past two years, Microsoft's trailing 12-month P/E has bounced between 12 to 19. Assuming that a midpoint P/E of 15.5 is "fair value" for the stock, Microsoft's estimated EPS of $2.66 for fiscal 2015 would translate to a "fair" price of $41. But that also means that the stock has limited downside after its post-earnings plunge.

The verdict
In my opinion, Microsoft is neither a bargain nor a bull trap in the lower $40s. For now, it's just a dependable income stock which will likely trade sideways until investors can fully measure the success of Windows 10.

If Windows 10 connects phones, tablets, PCs, and Xbox One consoles into a "One Windows" ecosystem and accelerates the growth of its cloud division, Microsoft stock could be undervalued. But if Windows 7 and 8 users refuse to upgrade out of fear of a "bait and switch" to a subscription-based model, its Windows cash cow could bleed out and cause the stock to tumble further.


This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.