Microsoft's stock fell after the earnings report? Morgan Stanley: The company's growth is accelerating, the market got the focus wrong

After Microsoft released its first fiscal quarter report for 2026, its stock price unexpectedly fell. Morgan Stanley analysts believe that the market completely missed the point, ignoring signals of accelerated growth.

According to news from the trading desk, on October 30, Morgan Stanley published a research report stating that investors are fixated on the slight 1 percentage point gap between Microsoft Azure's growth and market expectations, yet overlooked a series of overwhelming evidence indicating that the company's growth is "accelerating," such as a 111% surge in commercial orders and future revenue indicators accelerating to 35%.

Therefore, the report emphasizes that Microsoft's growth is not slowing down but is constrained by capacity, and its strong fundamentals and leadership position in AI are far from being reflected in the current stock price.

Morgan Stanley analysts not only maintained their "overweight" rating and "top pick in large-cap software stocks" status but also raised the target price from $625 to $650.

Stock Price Drop After Earnings Report? The Market is Completely Wrong

After announcing its earnings report, Microsoft's after-hours stock price fell by about 4%. The market is mainly concerned about three points, but Morgan Stanley believes these concerns are unfounded.

Azure's growth did not meet the most optimistic expectations:

• The market seems to be troubled by Azure's 39% (at constant exchange rates) growth, as it exceeded the company's guidance of 37% but fell short by one percentage point of some investors' expectations of 40%.
• The report emphasizes that this is a serious misreading. Microsoft's CFO clearly stated that the company is currently still in a "supply-demand imbalance," with demand growth even outpacing capacity construction.
• Therefore, the report emphasizes that the bottleneck in Azure's growth is physical supply, not weak demand.

Earnings per Share (EPS) growth is not significant:

• The earnings report showed an EPS of $3.72, only 0.04 dollars higher than the market expectation of $3.68. However, there is a key detail hidden behind this: Microsoft confirmed over $4 billion in losses from its equity investment in OpenAI this quarter.
• Excluding this non-operational impact, Microsoft's EPS would reach $4.13, a year-on-year increase of 21%, far exceeding market expectations.
• The report points out that this loss is merely an accounting treatment and will significantly ease in the future.

Significant increase in capital expenditures:

• Microsoft expects capital expenditure growth for fiscal year 2026 to exceed last year's 58%, meaning an investment of at least $140 billion. The market views this as cost pressure.
• However, analysts believe this is precisely the strongest evidence of extremely strong demand. Company management stated that "the acceleration of demand signals exceeded expectations," leading to more aggressive investments to capture the market and consolidate its leadership position in software and AI.

Growth is Accelerating, Not Slowing Down

The report analyzed multiple solid pieces of evidence for Microsoft's growth, especially the exceptionally bright performance of forward-looking indicators.

First, commercial bookings increased by as much as 111% year-on-year (at constant exchange rates). This is driven by large contracts from OpenAI and multiple Azure deals worth over $100 million. Notably, this does not include the newly announced $250 billion contract with OpenAI on October 28.

Secondly, as a key forward-looking indicator for measuring future commercial revenue, the current remaining performance obligations (cRPO) surged from 22% year-on-year growth last quarter to 35% this quarter, with a balance of $157 billion.

This accelerating trend suggests that Microsoft's commercial revenue growth will gain stronger momentum. At the same time, total remaining performance obligations (RPO) also grew by 51% year-on-year, reaching approximately $400 billion.

Management stated in the earnings report:

All demand signals, such as orders, remaining performance obligations, and product usage, have accelerated beyond our expectations.

Profitability Exceeds Expectations, Margin Continues to Expand

In addition to impressive growth metrics, the research report emphasizes that Microsoft's profitability also far exceeds expectations.

During the reporting period, the company's gross margin reached 69.0%, exceeding market expectations by 130 basis points.

Even as the proportion of Azure business continues to rise (which typically lowers gross margins), Microsoft has still maintained its profit margins by improving the efficiency of its cloud product portfolio.

Even more impressive is the operating profit margin, which reached 48.9%, not only a year-on-year increase of 230 basis points but also exceeding market expectations by 230 basis points.

The report points out that this is driven by the company's leverage effect through the use of artificial intelligence and strong operational control.

Additionally, free cash flow grew by 33% year-on-year, reaching $25.7 billion, achieved even with a 30% increase in cash capital expenditures, demonstrating the company's strong cash-generating ability.

Morgan Stanley: Microsoft is at the Core of the AI Wave

Based on the above analysis, Morgan Stanley believes that the market's negative reaction to Microsoft's earnings report is misguided.

Microsoft has demonstrated accelerating revenue growth, expanding operating profit margins, and management's commitment to actively invest to capture strong demand.

Morgan Stanley analysts believe that based on their forecast of $20.40 earnings per share for the 2027 calendar year, Microsoft's current stock price corresponds to a price-to-earnings ratio of about 26 times, which does not reflect its top-tier revenue growth sustainability and significant profit expansion potential.

Therefore, Morgan Stanley raised Microsoft's target price from $625 to $650 and reiterated its "Top Pick" and "Overweight" rating among large software stocks.

The report emphasizes that Microsoft is at the core of almost all major software demand trends, including cloud computing, AI, security, and digital transformation, and the market's downturn reaction provides a better buying opportunity for long-term investors.