Equity Research
Rating: BUY | 12-M Price Target: $560 | Upside: +10% | Current Price: $510
Rating & Price Target
Microsoft is a Buy with a price target of $560. This is 9.8% higher than $510 and 10.5% higher if you include the dividend. Microsoft Azure grew 43% in the last quarter ended 6/30/2026 (FY26 Q4 / Cal Q2 2026). They expect growth of ~45% next quarter. Microsoft 365 Copilot has over 30M paid seats. Their operating margin was around 47% this past year. The risks here are they are investing heavily in data centers $115.9B this past fiscal year vs $67B in free cash flow. And their dependence on OpenAI. There is little room for upside at this point since its not a cheap stock on cash flow.
Our view: we have a positive to the earnings story and neutral on valuation. We have a high conviction view that demand is outstripping Microsoft's ability to meet it using data from the company. Our less confident view is that they will be rewarded for their spend based on estimates. Risk is that depreciation will increase faster than sales.
Company Overview
Microsoft closes out there fiscal year on June 30th. They made $331.8B in revenue last year FY26. With operating income of $155.2B and EPS of $17.95. Here are their 3 segments:
Productivity and Business Processes: $140.0B (Microsoft 365, Linkedin, Dynamics 365 and Copilot)
Intelligent Cloud: $137.8B (Azure, servers and github as well as Nuance)
More Personal Computing: $54.1B (Windows, Xbox, Bing and Surface devices)
As you can see they have AI throughout all 3. Microsoft has ~27% ownership of OpenAI. Which in return will purchase $250B worth of Azure. These terms were changed in April 2026 to be non exclusive and Microsoft no longer receives revenue from them. Microsoft is also creating their own chips (Maia and Cobalt). And investing in Anthropic.
Our View: We think Microsofts revenue will continue to shift towards Intelligent Cloud. It grew 32% in Q4 vs More Personal Computing decreasing 4%. This will increase their growth rate but decrease margin. Intelligent Cloud makes around 41% margin compared to Productivity and Business making around 58%. We are very confident in this statement. But not how much cheaper Microsoft can get their chips.
Recent Financial Performance
Here are the past 4 quarters:
FY26 Q1 (ended 9/30/25): Revenue ~$77.7B. Op Margin ~49%. Non GAAP EPS $4.13. Azure grew 40%.
FY26 Q2 (12/31/25): Revenue $81.3B. Op Margin 47%. EPS $4.14. Azure grew 39%.
FY26 Q3 (3/31/26): Revenue $82.9B. Op Margin 46%. EPS $4.27. Azure grew 40%.
FY26 Q4 (6/30/26): Revenue $90.0B. Op Margin 45%. EPS $4.74. Azure grew 43%.
Some takeaways:
Beat in Q4 but had some one time gains of ~$0.27 in EPS. $3.2B gain from Anthropic.
Cloud GM declined from 68% to 65% during the year due to AI hardware.
Backlog (commercial rpo) was at $678B and grew 84%. Without OpenAI it would have been 25% growth. OpenAI accounted for ~45% of backlog in Q2 and likely around 1/3 now (3rd party estimate).
CapEx was around $41B including leases in Q4. Guidance for next quarter > $50B.
Revenue has grown from ~$212B (FY23) to $331.8B (FY26). That's a 16% growth rate on a yearly basis.
Cyclical areas are PC sales, Xbox and Advertising. Structural areas will be AI driving cloud growth and Copilot.
Our View: Demand is high which will allow them to grow EPS. However margins are declining on cloud. Down 3 points y/y. Market is assuming op margins stay around 46%. One thing to watch is depreciation expense was $38.5B in FY26 and was $29.4B in the prior year.
Growth Drivers
Azure: is growing at 40%+ off of a base over $100B. Will continue to grow above 38% into FY27.
Copilot: 30M seats equates to ~6-7% penetration against our assumed 450M+ seat count. $30 list price = ~$10.8B annual revenue before discounting. Assume they reach 60M seats by EOY FY27.
OpenAI: they are a shareholder, customer and competitor. They can now purchase compute from Oracle and Amazon as well.
Other: Bing Ads +10%, LinkedIn +12% and Xbox Content -10%.
Risks: Google, AWS + Anthropic, Sales Force/Service Now and AI agents eating into user seat based pricing models.
Our View: We think Azure/Copilot can drive mid to high teens growth. However, we think most of this is priced in. Main concern is if OpenAI moves more workload to other cloud providers.
Capital Allocation & Balance Sheet
Cash flow: had $182.9B in operating cash flow, spent $115.9B on capex and generated ~$67.0B in FCF (vs $71.6B prior year).
Shareholder returns: $26.4B of dividends + $22.3B in buybacks = ~73% of FCF.
Balance Sheet: $76.8B in cash and ~$40.3B of debt = ~$36B net cash position. Microsoft should have AAA credit ratings (confirm).
Philosophy: Like to partner (ie OpenAI/Anthropic) and make large strategic acquisitions (ie Activision).
Our View: We think they will start investing their cash instead of returning it to shareholders. This would be neutral to short term EPS and a headwind to FCF/share. Will become more cautious if we see FCF margins around 20% and net cash position go away.
Competitive Benchmarking
Below I have trailing P/E, EV/EBITDA, Capex as % of Revenue and Operating Margin. The final three stats will be based on their most recent fiscal year end so may not be apples to apples.
Microsoft: 28.8x, 14.2x, 34.9%, 46.8%.
Alphabet: 17.1x, 24.8x, 22.7%, 32.0%.
Amazon: 20.2x, 17.2x, 18.4%, 11.2%.
Meta: 27.4x, 16.4x, 34.7%, 41.4%.
Apple: 38.2x, 26.4x, 3.1%, 32.0%.
Oracle: 22.3x, 26.1x, 82.6%, 30.6%.
Nvidia: 29.6x, 33.8x, 2.8%, 60.4%.
No multiples available for OpenAI or Anthropic as they are private companies.
We think Microsoft is attractive at these levels given its 47% margins and average multiple. With Oracle having such a high capex figure of 82.6% and negative FCF there is room for overspend. Microsoft is self sufficient in funding this growth. Peers increasing capex may provide more supply which can lead to lower prices in cloud.
Moat & Risks
Moat is created through bundles (M365, Teams, Windows), switching cost and developers (Github, vs code). Enterprise customers also trust Microsoft with there workloads (Azure). Commercial grew at around 6% annually.
Risks:
OpenAI we think this can be renegotiated or concentrated.
Pricing ai agents may lower price per seat.
Capital expenditure. Could decrease return and margins.
Power lack of power can impact Azure.
Regulation FTC/EU can go after them.
Competition Azure is number 2 behind AWS.
Supplier Nvidia
Cyber Security
Our View: We think their moat will continue to grow just not by locking customers into seats. Which is a wash on earnings. Biggest risk that we dont have a size for is OpenAI.
Valuation
At 510 Microsoft is trading at the following multiples
Trailing P/E of 28.4x compared to a 5yr average of 34.0x and peer average of around 25.8x.
EV/EBITDA of 19.4x vs 23.2x and roughly 24.1x.
EV/FCF is about 56x vs around 40.3x and around 47x.
Forward P/E of around 26x.
We think Microsoft is undervalued on earnings and EBITDA and overvalued on FCF. As their FCF margin has come down from 25% to 20% due to capex spend. We would say its fairly valued with some upside.
Our View: We think 26x forward earnings is fair for high teens growth. We are more bullish on earnings than cash flows. Assuming FCF margin will bottom out around 20% and build from there.
Scenarios
Bull Case -$700 (+37%) - Azure growing over 45%, Copilot seats above 60M and margin stabilizes. We see EPS compounding at close to 20% for the next 3-5 years.
Base Case - $560 (+10%) - As more capacity comes online we should see FCF grow. EPS to grow at mid to high teens over the next 3-5 years.
Bear Case - $420 (-18%) - Renegotiation with OpenAI, pricing in AI and capex pauses. Growth slows to low double digits over the next 3-5 years.
Probability weighted we come to a price target of $560.
Our View: We think this is fairly balanced risk and reward but slightly skewed to the upside. We would alter our thesis if we saw Azure slow below 38% and higher capex guidance.
Capital Market Signals
Blackrock Vanguard and State Street all bought more shares in the last quarter. Analyst ratings are high with average price target around $570 and low/high around $430-$870. Satya Nadella sold ~$43.4M worth of shares in September and Amy Hood ~$20.8M these are likely normal sales. Bill Gates has a very small stake (check this) no dual class shares.
Our View: Passive Investors buying and analyst prices target high. Everyone knows this. The spread in prices target shows where people think AI will make money.
Conclusion
Buy, $560 Target. Good for Pension and Sovereign fund money that can hold for 2-3 years plus. Core holding at benchmark or slightly overweight. Add around $470 and trim over $600. Would reassess if we saw Azure slow to below 38% or openai deal changed.
We believe this stock is a Buy on Quality and Visibility. Not a cheap stock.