Microsoft's Profit Soars 31%, Stock Slips: What's Next?

Microsoft just reported stellar fiscal 2026 results: revenue jumped 18% to $331.8 billion, and net income soared 31% to $133.7 billion. Yet, the stock is down about 4.5% from a year ago, with the market cap at $3.59 trillion. How can a company grow profits by nearly a third and still see its stock decline?

The answer lies in valuation. A year ago, investors paid 37 times earnings for Microsoft; today, they pay 27 times. That's a 27% drop in the price-to-earnings ratio, offsetting the earnings growth. The market is clearly re-rating the stock, and the reason is twofold.

First, there's a broad sell-off in software stocks due to fears of AI disruption. Second, and more specifically, Microsoft's capital expenditures are exploding. The company spent $115.9 billion on property and equipment in fiscal 2026, up 80% from the prior year. For calendar 2026, CFO Amy Hood guided to about $175 billion in capex, which exceeds the company's entire operating income of $155.2 billion.

This massive spending on AI infrastructure is raising concerns about returns. While operating cash flow rose 34% to $182.9 billion, free cash flow actually declined to $67 billion from $72 billion. The market is worried that these investments may not pay off as expected, especially if AI demand doesn't materialize as strongly as hoped.

In contrast, Apple, which spends relatively little on capex, has seen its stock rise about a third over the past year. Investors are rewarding companies that touch customers directly and spend minimally, while discounting those building the underlying computing layer.

For investors, the key takeaway is that Microsoft's earnings growth is being overshadowed by its massive AI infrastructure spending. The $175 billion planned capex for 2026 is more than the company's entire operating income, which is a red flag for some. If AI demand doesn't grow as expected, Microsoft could face overcapacity and depreciation costs that eat into future earnings.

This explains why the stock is trading at 27 times earnings, a discount to Apple's 35 times. The market is pricing in uncertainty about the ROI on Microsoft's data center buildout. However, there's a silver lining: Microsoft's backlog of contracted work (commercial RPO) hit $678 billion, up 84% year over year, indicating strong future demand.

If Azure continues to grow at near 40% and capex stabilizes, the current valuation could look cheap. But if AI spending doesn't translate into profits, the stock could remain under pressure. The market is essentially asking: will Microsoft's AI bet pay off?

For now, the skepticism seems justified, but not overly bearish. The stock is a hold, not a buy, as the risk-reward is balanced. Investors should watch Azure growth and capex trends closely in coming quarters.