Financial report data is impressive, but shares fell 7% pre-market; where did Microsoft's market expectations fall short?

Microsoft's fiscal 2026 second quarter report released Tuesday showed that both revenue and profit exceeded Wall Street expectations, yet its stock price came under pressure and declined during after-hours trading. The market sentiment fluctuated mainly due to the gap between the surge in capital expenditure and the extent of acceleration in cloud business growth.

Microsoft's second quarter revenue reached $81 billion, a year-on-year increase of 17%, 1% higher than market expectations; non-GAAP earnings per share (EPS) were $4.41, up 23%, exceeding market expectations by 5%. The highly watched Azure cloud business grew 38% at fixed exchange rates, also slightly above Wall Street's expectation of 37%.

Despite solid core indicators, investors remain concerned about Microsoft's steadily rising capital expenditure. Data shows that the company's capital expenditure for the quarter was $37.5 billion, 9% higher than the general market expectation. The market had anticipated such massive investment would bring a significant acceleration in Azure's growth rate, but current data has yet to satiate this high appetite.

According to the latest Goldman Sachs report released January 28, despite short-term stock price fluctuations, Microsoft's current strategy is to sacrifice short-term Azure revenue growth to prioritize computing power needs for first-party applications (like Copilot) and internal R&D (such as Microsoft AI). Goldman Sachs maintains a "Buy" rating for Microsoft but has lowered its 12-month target price from $655 to $600, considering uncertainties around the timing of capital expenditure conversion into revenue growth.

Mismatches Between Capital Expenditure and Growth Raise Concerns

Goldman Sachs believes that the negative market reaction to Microsoft's stock mainly reflects investor anxiety over persistent higher-than-expected capital expenditures for several consecutive quarters. The single-quarter $37.5 billion expenditure (including financing leases) indicates Microsoft is aggressively building AI infrastructure. However, such spending has not immediately translated into a proportionate leap in Azure's growth rate.

Analysis points out that this is actually a strategic trade-off by Microsoft. The company is prioritizing valuable computing resources for strategic products such as Copilot and internal R&D, rather than solely chasing short-term external Azure revenue. Goldman believes this approach will eventually position AI more strategically across multiple layers of the tech stack and deliver better returns in the medium term.

Azure Faces Capacity Constraints, Not Lack of Demand

Regarding its core cloud business, Microsoft's management revealed that Azure is currently facing capacity limitations. Goldman Sachs stresses that investors should view Microsoft's third-quarter Azure growth guidance of 37%-38% as "based on capacity allocation ability," rather than simply a reflection of demand. This means that under capacity constraints, the upper limit of any particular quarter's performance is essentially set.

Estimates in the report suggest that if Microsoft had not tilted capacity toward first-party applications and internal R&D in the past two quarters, Azure's revenue growth rate would have exceeded 40%. Against this backdrop, with the launch of new capacity (such as the Fairwater project) and easing supply chain constraints, Azure is expected to enter its next phase of strong performance. In addition, the MAIA 200 chip released on January 26 is seen as a positive signal, with benchmarks showing it outperforms competitors' internal chips, making it a key driver of future margin and price-performance differentiation.

Copilot’s Commercialization Path Becoming Clearer

Although cloud infrastructure garners much attention, AI monetization at the application layer is accelerating. Microsoft notes that Copilot adoption and usage are rapidly increasing, with M365 Copilot seats up 160% year-on-year and paid seats reaching 15 million.

Goldman Sachs analysis finds that, compared to Azure, Copilot will enjoy better customer lifetime value and lower acquisition cost (LTV:CAC). This is mainly due to Copilot’s higher gross margin (stronger pricing power than Azure) and higher customer stickiness. Although M365 commercial cloud’s growth guidance has eased slightly to 13%-14%, that somewhat reflects new seats being added at lower average revenue per user (ARPU)—such as frontline workers and SMEs. Industry conversations indicate that Copilot’s output quality is improving; with new SKUs and features (like WorkIQ) being introduced, its functionality will continue to enhance.

Valuation Adjustment and Potential Risks

Based on the limited visibility of the timeline for capital expenditure turning into revenue growth, Goldman Sachs has adjusted its valuation model for Microsoft. The analysts lowered the target P/E ratio from 32x to 28x, and cut the target price to $600.

The report also lists key downside risks faced by Microsoft, including: income contribution from cooperation with OpenAI being lower than expected, prolonged ramp-up time for in-house chip capacity thus limiting market share gains or margin expansion, investment in non-Azure projects exceeding expectations, significant changes in key leadership, and the more pronounced shift toward custom software potentially having a negative impact on the application business. For Microsoft shares to outperform the market, more actual evidence of Copilot’s success in generating income, validation of internal R&D commercialization, and a renewed acceleration in Azure growth as new capacity comes online are needed over the next 6 to 12 months.

Risk Warning and DisclaimerThe market has risks, investment requires caution. This article does not constitute personal investment advice, nor does it take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinion, viewpoint, or conclusion in this article fits their particular circumstances. Investment decisions are the user's own responsibility.