Microsoft Corp

Microsoft has shown strong performance, rallying 24.6% in USD as the market reacted positively to its earnings release. The company is part of a group of hyperscalers expected to significantly increase capital expenditure, with FY26 capex expectations rising from around $536bn to $784bn. This increase reflects the ongoing demand for AI-related infrastructure, which is crucial for maintaining its competitive edge. Despite concerns over the economics of rising investments, Microsoft remains a key player in the AI and data center space, benefiting from its strong cash generation and recurring revenue model.

Microsoft's investment in AI is significant, with forecasts indicating that it will spend in excess of 400 billion dollars in 2026 alongside other hyperscalers. The company has also adjusted its accounting estimates, increasing the useful lives of its computer equipment from two to six years. This change lowers annual depreciation expenses, which can boost reported earnings. However, the divergence between earnings per share growth and free cash flow per share growth across hyperscalers highlights the importance of cash flows, which cannot be manipulated by accounting changes.

Microsoft (MSFT) was our best performing stock in July, after reporting better-than-expected operating results that showed a reacceleration in Azure and CoPilot growth. Importantly, despite continued investments in AI, Microsoft is managing its cashflow better than other hyperscalers, even reducing its capex for 2026. Looking ahead, we believe that the company is well positioned to maintain Azure Cloud growth and newly reengineered software products that integrate AI should provide sustainable growth.

Microsoft's share price trades at one of its lowest earnings multiples of the past decade, reflecting investor concerns around AI disruption to the company's core M365 productivity suite and the growth prospects of its Azure cloud business. However, we believe M365's deep embeddedness in daily workflows, superior price-to-value proposition and proprietary Copilot AI agent make it far more resilient to AI disruption than point solution software. Azure, the second largest public cloud hyperscaler, is well positioned in a supply-constrained compute market, and its capital expenditures are prudent investments to accelerate growth. Together, we believe that these tailwinds should enable Microsoft to sustain its high-teens historical earnings growth algorithm over the long term.

Microsoft is no longer among our top 10 holdings. We have rebalanced the portfolio weights between Alphabet and Microsoft. We remain comfortable with the Azure hyperscaler business although we believe it may be less well positioned than Alphabet’s GCP and Amazon’s AWS hyperscaler businesses. We still expect Azure to deliver strong growth and sound returns on its massive capital expenditure. Of course, Microsoft is considerably more than Azure. Some of its businesses, such as Xbox, are struggling, while others, such as the Windows operating system franchise, face cyclical challenges. Microsoft 365 is of critical importance – especially the ongoing development of Copilot.

Microsoft has demonstrated an impressive return on equity (ROE) of over 25% in the last 25 years, showcasing its ability to generate substantial profits. The company is part of a group of market leaders, including Nvidia and Alphabet, that are currently driving significant capital expenditures in AI infrastructure, with over USD 725 billion committed in 2026 alone. This strong cash generation capability positions Microsoft favorably in the evolving AI landscape, where the demand for its services is expected to grow. The long-term view on Microsoft remains positive as it continues to reinvest profits to expand its market share.

Microsoft is well-positioned to capitalize on the AI opportunity, as organizations need to modernize their IT systems to effectively utilize AI. With only about a third of business computing currently in the cloud, AI is expected to accelerate this migration, and Microsoft stands as the world's second-largest cloud provider. Additionally, its significant investment in OpenAI, where it holds exclusive rights to its IP for five years, provides a strong foundation for developing its own AI technologies. The integration of AI into existing products, such as Copilot for office workers, further enhances its ecosystem's value.

Microsoft is positioned to benefit significantly from the ongoing investment cycle tied to artificial intelligence, with an estimated $700 billion in investments from major tech players in 2026. This investment is expected to drive substantial earnings growth, reflecting high expectations from the market. The demand for data centers and the associated infrastructure is creating a bottleneck that will likely enhance profitability for Microsoft and its peers. The current market dynamics suggest that the company is well-placed to capitalize on these trends, reinforcing its competitive moat in the technology sector.

The current valuation of Microsoft, along with other 'Magnificent Ten' companies, is extremely inflated, reflecting unrealistic growth expectations. While Microsoft is a robust company, its high P/E ratio and significant capital expenditures in AI are concerning. The company, along with others, is expected to spend nearly $700B on AI in 2026, which may impair future performance and profitability. Historically, only one of the top ten companies during the internet revolution, Microsoft, generated excess returns over two decades, indicating the risks of investing in such high-flying stocks at their peak.

Microsoft is the world’s largest enterprise and consumer software company, with a strong position in AI and cloud services. AI presents a large opportunity for Microsoft, which it is pursuing with urgency. The company is well-placed as the second-largest cloud provider, and its investment in OpenAI provides a strong foundation for developing its own AI technologies. Microsoft is embedding AI into its existing products, enhancing their value. Despite concerns about competition and capital investments, its established market position and integration capabilities position it well for future growth.