Microsoft shares fall after earnings? Morgan Stanley: The company's growth is accelerating, the market is focusing on the wrong thing.

After Microsoft released its report for the first quarter of fiscal 2026, its stock price unexpectedly fell. Morgan Stanley analysts believe the market has completely missed the point and ignored signs of accelerating growth.

According to Chase Wind Trading Desk, on October 30, Morgan Stanley published a research report stating that investors are fixated on the tiny 1-point gap between Microsoft Azure’s growth and market expectations, while overlooking overwhelming evidence of accelerated growth, such as a surge of 111% in commercial bookings and a sharp rise to 35% in future revenue indicators.

The report therefore emphasizes that Microsoft’s growth is not slowing, but is instead limited by capacity; its strong fundamentals and leadership in AI are far from reflected in the current stock price.

Morgan Stanley analysts not only maintained their “Overweight” rating and “Top Pick among large-cap software stocks” status, but also raised the target price from $625 to $650.

Drop after earnings? The market is completely wrong

After releasing its earnings report, Microsoft’s stock price dropped about 4% after hours. There are three main market concerns, but Morgan Stanley thinks none hold water.

Azure's growth rate missed the most optimistic expectations:The market seems concerned that Azure’s growth rate of 39% (in constant currency) barely beat the company’s guidance of 37%, yet fell short by one percentage point compared to some investors' hopes of 40%.The report highlights this as a serious misinterpretation. Microsoft’s CFO clearly stated the company is still in a state of “undersupply” and demand growth is outpacing capacity building.Therefore, the report stressed that Azure’s growth bottleneck is physical supply, not weak demand.

Earnings per share (EPS) increase was limited:The earnings showed EPS at $3.72, only $0.04 above the market forecast of $3.68. However, a key detail is hidden behind this: Microsoft recognized losses of over $400 million from its equity investment in OpenAI this quarter.Excluding this non-operating impact, Microsoft’s EPS would be $4.13, up 21% year-on-year and far exceeding market expectations.The report notes that this loss is just an accounting treatment and will be significantly mitigated in the future.

Significant increase in capital expenditures:Microsoft expects capital expenditure growth in fiscal 2026 will exceed last year’s 58%, meaning total investment will reach at least $140 billion. The market treats this as cost pressure.However, analysts argue this is actually the strongest proof of extremely strong demand. Management says “the acceleration in demand signals exceeded expectations,” thus justifying more aggressive investments to seize market share and strengthen its leadership in software and AI.

Growth is accelerating, not slowing

The report analyzed multiple firm indicators of Microsoft’s growth, with forward-looking metrics appearing especially strong.

First, commercial bookings surged 111% year-on-year (in constant currency).

This was driven by large contracts from OpenAI and several Azure deals worth over $100 million each. Notably, this does not include the newly announced $250 billion OpenAI contract disclosed on October 28.

Secondly, as a key leading metric for future commercial revenue, current remaining performance obligation (cRPO) accelerated from 22% year-over-year growth last quarter to 35% this quarter, reaching a balance of $157 billion.

This accelerating momentum signals even stronger commercial revenue growth ahead for Microsoft. Meanwhile, total remaining performance obligation (RPO) grew 51% year-on-year to about $400 billion.

Management said in the earnings report:

All demand signals, such as bookings, remaining performance obligations, and product usage, are accelerating at a faster pace than we expected.

Profitability exceeds expectations, margins keep expanding

Beyond impressive growth metrics, the report also highlighted Microsoft’s profitability far exceeding expectations.

During the reporting period, company gross margin reached 69.0%, 130 basis points above the market consensus.

Even as Azure’s share of business continues to rise (which typically drags down gross margin), Microsoft still stabilized its profit space by increasing the efficiency of its cloud product mix.

Even more striking is its operating margin, which hit 48.9%, up 230 basis points year-over-year and 230 points above market expectations.

The report says this is due to the company leveraging AI and strong operational control to drive scale effects.

Additionally, free cash flow grew 33% year-over-year to $25.7 billion, even as capital expenditures in cash increased 30%, showing strong cash-generating capability.

Morgan Stanley: Microsoft is at the core of the AI wave

Based on the above analysis, Morgan Stanley believes the negative market reaction to Microsoft’s earnings is mistaken.

Microsoft has shown accelerated revenue growth, expanding operating margins, and management’s determination to invest aggressively to capture strong demand.

Morgan Stanley analysts believe that based on their estimate of $20.40 in EPS for the calendar year 2027, Microsoft’s current share price corresponds to about a 26x P/E ratio, which does not reflect the company's premium revenue durability and massive profit expansion potential.

For this reason, Morgan Stanley raised its target price for Microsoft from $625 to $650 and reaffirmed its status as “Top Pick” and “Overweight” among large software stocks.

The report stressed that Microsoft is at the center of almost every major software demand trend—cloud, AI, security, digital transformation—and the market’s drop provides long-term investors with a better buying opportunity.

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