Sign number 1,327,342 that the market is anything but rational: Shares of Microsoft (NASDAQ:MSFT) were up more than 10% in late trading, after the company reported the first year-over-year profit decline in its history.

Mr. Softy's third-quarter results read like a damage report:

  • Revenue fell 5.6%, while net profit declined 32%.
  • Four out of five of Microsoft's business units recorded lower sales, including a 16% drop in its core Windows business.
  • Quarterly cash from operations fell 14.7% to $6 billion.
  • Per-share earnings took a $0.06 hit, thanks to $290 million in severance and $420 million in investment writedowns.

How could all that result in enthusiastic buying? Apparently, investors and analysts feared much worse. They worried that Microsoft, like Boeing (NYSE:BA) and Netflix (NASDAQ:NFLX), would fall short of the Street's expectations.

"The fear was a billion-dollar shortfall," analyst Sandeep Aggarwal of Collins Stewart told The Wall Street Journal. Instead, investors cheered when Microsoft's $13.65 billion in revenue was only $500 million less than the consensus estimate.

They also applauded the forthcoming arrival of Windows 7, set for release in fiscal 2010 alongside plenty more upgrades and new products. As Chief Financial Officer Chris Liddell put it during yesterday's earnings conference call:

Office will be coming out with a new version, Exchange will be coming out with a new version. We have got potentially a new search product coming out in the foreseeable future. So you will see, in all of our major products, a significant release in the next, let's say, 12 months.

Call it a do-over, a chance to erase memories of the troubled Vista operating system and challenge would-be usurpers Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG).

I'd applaud that, too, were I a Microsoft investor.

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Google is a Motley Fool Rule Breakers recommendation. Apple and Netflix are Motley Fool Stock Advisorselections. Microsoft is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers had stock and options positions in Apple and Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. The Fool's disclosure policy wonders why it's so soft in the middle when the rest of life on Wall Street is so hard.