Microsoft is riding the wave of long-term growth through AI and cloud

By Nabeel Bukhari

Overview

• Microsoft reported 1st FY25 revenues of $65.6 billion, up 16% year-on-year, driven by strong performance across key segments and strategic investments in artificial intelligence and innovation.
• Azure’s AI-driven growth positions it as Microsoft’s main profit driver, with management forecasting sustained high growth as AI infrastructure scales and adoption accelerates.
• Despite trading at premium valuations (33x earnings), Microsoft’s strong balance sheet, high margins and AI-focused growth strategies justify its long-term investment appeal.
• While risks such as competition and regulatory challenges exist, Microsoft’s leadership in artificial intelligence and cloud positions it well for continued growth, making it a compelling long-term buy.

Microsoft Corporation (MSFT, Financial) is a brand familiar to many, and its system integration is part of the lives of millions of people globally. In an unusual irony, however, the stock has not risen as much as expected given the tech industry’s phenomenal growth in recent years. Nevertheless, Microsoft is still a giant and one of the biggest winners in the generative AI race. Its partnership with OpenAI is not only helpful for Azure’s revenue growth, but also gives the company a strong role in AI-driven innovation.

While Microsoft doesn’t scream value at the moment, its ability to generate robust double-digit growth with unmatched cash flow generation is almost impossible to ignore. Although I’ve pulled back on some of my biggest growth winners, Microsoft remains an outstanding stock with great long-term potential and the ability to deliver big returns.

Growth in Q1 and AI investments pave the way

Microsoft’s Q1 2025 earnings report shows that the company is fully charged with healthy growth rates combined with progressive investments.

The company’s total revenue rose 16% year-over-year (YOY) to $65.6 billion, accelerating from the previous quarter’s growth rate of 15.2% and 12.8% in the same period last year. Earnings per stock wasn’t far behind, rising 10% to $3.30 in part due to smart investments in artificial intelligence (AI) and the dilution of Activision Blizzard. Both factors, although modestly affecting profits in the short term, are in reality strategic actions taken with the aim of securing long-term control of the company.

Let’s break down Microsoft’s key segments to better understand what’s driving this growth and where the company might be headed.

The essence of Microsoft is in its Productivity and Business Processes segment, which is still the biggest source of both income and profit for the company at the moment. This segment generated revenue of $28.3 billion, up 12% and ahead of the company’s guidance of 10%, primarily driven by strong adoption of enterprise products such as Microsoft 365 Copilot that incorporate AI. Management guidance of up to 11% growth next quarter supports the view that companies will maintain efficiency through advanced AI capabilities.

Still, all the focus is on Azure, the crown jewel of the Intelligent Cloud segment (up 20% and generating revenue of $24.1 billion) for Microsoft. Azure itself is up a monstrous 33%. Such acceleration proves the company’s strength and its close connection with OpenAI, which not only enhances Azure, but also brings in new customers eager for the best AI solutions. While management has forecast an astounding 32% growth next quarter, this is expected to pick up in the second half as more AI capabilities come online. Azure’s growth path may surpass the productivity segment to become the new cash cow for Microsoft.

Last but not least, the More Personal Computing segment’s revenue of $13.2 billion, up 17%, is still more cyclical than the rest of the segments. Management expects revenue in this segment to be slightly lower compared to the previous year due to more difficult comparisons. However, the inclusion of Activision Blizzard as part of this segment points to long-term growth. The acquisition had a $440 million dilutive effect on operating income this quarter, but synergies and cost discipline should help turn it into a growth driver.

Also, Microsoft is a fortress with $116.2 billion in cash at the end of the quarter against $45 billion in debt.

Looking at the graph above, it is clear that the buffer has shrunk significantly compared to previous years. Well, it is due to increased capital expenditure for heavy investment. In 2023 the ratio dropped below 1.5, but the good news is that it has since recovered, back to 1.28. This decline doesn’t take away from the fact that Microsoft is in a great financial position and is well positioned for a steady growth trajectory as its AI-driven investments mature.

Microsoft stock valuation and growth potential

As of recent prices, MSFT found itself trading at around 33x earnings.

Consensus estimates show that the stock will have higher double-digit growth rates in the coming years. I consider these estimates reasonable based on Azure’s stellar momentum.

The stock may not even appear to be an obvious bargain at around 12x sales, as this multiple ranks high compared to other software companies. However, I would like to emphasize that some premium is deserved as MSFT already earns such high profit margins and therefore its high earnings yield will contribute to the continued return outlook. Longer term, I still expect GAAP net margins to reach 45%-50% as operating leverage starts to kick in, up from 37.7% last quarter. This effectively put the current valuation at 25x long-term earnings, which could be considered reasonable given the strong balance sheet and long-term secular growth. Between the consensus estimate of double-digit revenue growth and the roughly 3% earnings yield, I think this stock could deliver between 15% to 17% compounded annual returns for the next five years or more. To earn a return less than that expected by the above formula, the company must either underperform consensus growth estimates or the stock’s valuation must compress. Even if we assume the stock trades at 21x long-term earnings in five years, the stock will return between 12% to 14% per year and will therefore outperform the market’s average return of 8%.

MSFT trades at a slight premium to its 5-year average, but is still not as overvalued as one might think given the current tech euphoria and the company’s position in it.

Over the past five years, Microsoft’s stock has risen by 160.58% as shown in the graph below, which shows that the company has good opportunities in fast-growing sectors such as cloud computing, AI and enterprise software. But this performance also speaks to a market willing to pay a premium for stable and consistent growth.

Currently, the stock’s valuation multiples, as I discussed earlier, are both significantly higher than Microsoft’s historical ratios and its sector’s median.

What’s next for the stock?

For the past year, Microsoft had a return of 12.40%, but that doesn’t compare to the kind of growth seen in the past due to market fluctuations. The stock rose to $450 in mid-2024, but has since corrected to trade in the $410-$425 range. This correction may come from valuation concerns and other market factors rather than company-specific issues. However, it is important to note that the $400 level is the critical support zone, as investors consider any price drop close to this range to be a good buying opportunity.

Nevertheless, the current trading price of the stock reflects a lack of enthusiasm among investors to drive valuations even higher. $468.35 as a 52-week high is a major resistance point, while $450 has served as the ceiling over the past year. Penetrating this barrier would require Microsoft to post stellar earnings or for market sentiment to change. On the other hand, lack of high expectations could cause the stock to retest the $400 support level.

In the near term, Microsoft stock is unlikely to move much beyond the $400-$450 range as investors assess its valuation against growth potential. The long-term stable scenario of maintaining double-digit top-line growth rates along with GAAP net margin growth of 45% may justify further price increases.

Investors should be cautious of market risk and ensure that the stock’s valuation is correct in relation to their investment horizon and risk tolerance. Microsoft’s fundamentals are good, but near-term gains are expected to depend on its ability to beat high-end forecasts.

Risks for my thesis

The outlook seems favorable for Microsoft, but there are some risks that may affect the thesis I have described above. First, lower-than-expected AI adoption is a major concern. The growth story draws heavily on Azure’s performance, relying on AI-powered tools like Microsoft 365 Copilot. However, delays in the adoption of these tools or issues related to the implementation of the same may slow overall AI and Cloud service revenues as expected. This can also slow down the overall growth of the company.

Another significant risk is the threat to competitiveness that Microsoft experiences most in the cloud as well as the AI ​​segments. Azure has been a good performer, but in front of Microsoft are giant competitors such as Amazon Web Services (AWS) and Google Cloud, both of which are actively using similar technologies. If these competitors develop further, or if Azure’s expansion is stymied by more competition, then the rate of revenue expansion, which is at the heart of the thesis, could be affected.

Last but not least, regulatory challenges cannot be ignored. Microsoft is under increasing pressure from regulators, particularly due to the Activision Blizzard acquisition. If regulatory bodies intervene or place restrictions on the company, there may be unhealthy obstacles or complicity in the company’s expansion strategies. New regulations for Big Tech can also become an issue, which, along with existing problems, can bring additional risks to the company’s future. These risks are noteworthy given that they can affect both growth and valuations.

Your takeaway

All in all, Microsoft remains a good stock for the long-term investment. This is achieved under the leadership of Azure, which is driving impressive growth and with the company now putting more emphasis on AI, it gives the impression that it is ready to take advantage of some of the most promising technological trends. Sure, the stock is a tad on the expensive side, but when you look at the cash flow, healthy margins and growth opportunities on offer, the premium demanded for the stock seems well-deserved.

Of course, there are a few risks, but Microsoft has proven its abilities to overcome obstacles and be at the forefront of innovations. So as long as it continues to deliver in the AI ​​and cloud sector as it has done before, I think the stock will continue to deliver good returns. I would recommend Microsoft to anyone looking for solid, market-beating growth in technology, as the company has sound financials and leads in high-growth areas. It’s a stock you can hold and expect it to pay off for many years to come.