Underestimating the turning point for Azure and Copilot! Morgan Stanley: The market giving Microsoft only a “16x PE” is too low.

Morgan Stanley believes Microsoft is at a key turning point in the AI monetization cycle, while the market seems to have yet to fully price in this opportunity.

According to Wind Chasing Trading Desk, on July 21, the Adam Wood team at Morgan Stanley released a research report, stating that Microsoft Azure’s cloud business growth is about to enter an accelerated phase, and Copilot’s commercialization path is evolving from a single seat charge to a three-pronged expansion opportunity.

The report points out that based on the current stock price, the implied PE ratio is only about 16 times, but for a tech giant expected to deliver over 20% earnings growth, a 16x PE clearly underestimates its intrinsic value.

Although the bank recently lowered Microsoft's 12–18 month target price from $650 to $600, considering gross margin pressure, increased capital expenditure, and debt, it still maintains an "Overweight" rating, implying about 50% upside from the current stock price.

What does “16x PE” mean?

Simply put, “16x PE” means Microsoft’s current valuation is seriously underestimated by the market.

This figure is calculated by dividing Microsoft’s current stock price of $402.29 by Morgan Stanley’s forecasted earnings per share of $23.86 for fiscal year 2028.

In US stock valuation logic, a reasonable PE ratio typically should match the company's earnings growth rate, that is, PEG equals 1.

Microsoft’s projected growth for fiscal year 2028 is as high as 21.6%. Under normal circumstances, it should warrant a PE of at least above 21x. Similar large-cap software companies, due to higher certainty, even get a PEG of 1.4, meaning the 21.6% growth rate is magnified to about a 30x PE.

In contrast, the market gives Microsoft less than a 17x forward PE, meaning you are buying a high-growth giant, growing over 20% per year, at the price typically reserved for slow-growing companies.

Morgan Stanley believes this pricing logic is significantly biased. If conservatively re-evaluated using a PEG of 1.2 (lower than peers, corresponding to a PE of about 25x), and applying the 2028 forecasted earnings of $23.86, Microsoft’s fair target price should be around $600.

Azure: Supply Release Opens Acceleration Room

Improved Azure growth expectations are one of Morgan Stanley’s key positive catalysts for Microsoft.

（Microsoft Azure AI monetization model）

Over the past year, Azure’s growth bottleneck has been in insufficient supply. Microsoft’s management has continuously emphasized that customer demand exceeds available capacity, and the company needs to balance computing power distribution among external Azure users, first-party applications (such as Copilot), and internal R&D.

Microsoft CFO Amy Hood revealed in the F2Q26 earnings call that if all newly launched GPUs in Q1 and Q2 were allocated to Azure, Azure’s growth that quarter would have exceeded 40%, not the announced 38% (at fixed exchange rates).

With new capacity gradually coming onstream, Morgan Stanley believes these supply constraints are easing, and Azure’s growth is expected to accelerate sustainably.

Management has already given clear guidance for an acceleration in Azure growth in the second half of 2026 compared to the first half, with high confidence.

As a result, Morgan Stanley has raised Azure revenue forecasts, expecting Azure and other cloud services revenue to reach $214.9 billion and $305.9 billion in fiscal years 2028 and 2029, respectively, 5% and 7.8% higher than consensus.

（Morgan Stanley raises future annual Azure revenue forecasts）

Analysts believe the market underestimates the magnitude and sustainability of this Azure acceleration. Historically, once pent-up demand is released by increased capacity, growth tends to exceed expectations and persist for longer.

Copilot: From “Selling Seats” to Triple-Engine ARPU Expansion

Copilot’s monetization logic is undergoing structural change, and Morgan Stanley believes this is one of the most important ARPU (Average Revenue Per User) expansion opportunities in Microsoft’s history.

Over the past year, Copilot’s main topics have been product-market fit and feasibility of enterprise deployment scale. Now, the focus has shifted to paths of commercialization and long-term revenue scale.

Morgan Stanley summarizes Copilot-driven ARPU growth as three engines:

First, direct seat expansion for M365 Copilot;Second, enterprise customers migrating to higher-value M365 E7 subscriptions;Third, monetization models based on consumption billing such as AI Agents and workflow automation.

The launch of the E7 SKU is the core node in this strategic evolution. E7 bundles E5, Copilot, and Agent365, similar to the upgrade wave from E3 to E5 years ago, and is expected to start a new multi-year enterprise software upgrade cycle, pushing both ARPU and Copilot penetration rates higher.

According to Morgan Stanley’s latest CIO survey, 47% of enterprises currently use E5 licenses, 7% use E7; in the next year, the expected proportion migrating to E5 and E7 will rise to 50% and 21% respectively.

（Morgan Stanley expects next year’s subscription rates for E5 and E7 licenses will reach 50% and 21% respectively）

On the demand side, 88% of CIOs in Morgan Stanley’s latest survey said they plan to deploy M365 Copilot in the coming 12 months, a significant increase from 80% in Q4 2025 and 72% a year earlier.

（88% of CIOs expect to use Microsoft 365 Copilot in the next 12 months）

As a result, Morgan Stanley has sharply raised Copilot forecasts: expecting Copilot revenue to be about $4.4 billion in fiscal year 2026, rising to about $22.5 billion in fiscal year 2029.

Gross Margin Pressure, but Operating Profits Can Keep Expanding

Gross margin is one of the most widespread market concerns about Microsoft, but Morgan Stanley thinks this pressure is overinterpreted.

The bank lowered gross margin forecasts to 65.7%, 64.4%, and 63.4% for fiscal 2027–2029, mainly due to increased share of Azure AI and Copilot revenue, rising AI-related depreciation costs, and cost front-loading effects during major infrastructure construction periods.

However, Morgan Stanley also points out ongoing control of operating expenses is sufficient to offset gross margin pressure, so operating profit and earnings per share can still maintain growth above 20%. Operating profit margin forecasts for fiscal 2027–2029 are 46.5%, 46.7%, and 47.2%, showing a mildly expanding trend.

Historical precedent supports this judgment as well. Microsoft’s cloud business gross margin once dropped into negative territory at the FY14 construction peak, but subsequently recovered as capacity utilization improved, software efficiency increased, and scale effects appeared, rising above 70% by fiscal 2023.

（Azure AI margin trends outperform Azure during the same period）

CFO Amy Hood has repeatedly stated, at this stage, AI business gross margins are much better than the equivalent phase during cloud transition, and reiterated in the April 2026 earnings call:

The gross margin of our AI business is better than what we experienced during the cloud transition, and has always remained so.

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The above wonderful content is from Wind Chasing Trading Desk.

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