Microsoft Delivers the AI Relief Investors Were Looking For

As promised in our opening comments and our Meta (META) Alert out earlier, we are now focusing our attention on Microsoft (MSFT). So let’s discuss what in Microsoft’s Q2 2026 earnings report and corresponding call has pushed the shares up significantly Thursday.

Before we get to the meat of it, however, remember our discussion about the level of short interest heading into last night’s report and the number of days to cover. Not to take away from what Microsoft delivered and shared, but it does explain the size of the reaction we are seeing in the shares.

First the Nuts and Bolts

Microsoft delivered fiscal Q4 2026 EPS of $4.81, well ahead of the $4.24 consensus, on revenue that climbed 18% year over year and 9% sequentially, to $90.01 billion, also besting the $87.6 billion market forecast.

Operating income for the quarter also increased 18% year over year, delivering an operating profit margin of 41%, up from 40% in the March quarter.

Microsoft Cloud revenue was $59.3 billion, increasing 27%, and commercial remaining performance obligation rose 84% to $678 billion. Azure and other cloud services revenue advanced 43% with Azure revenue surpassing $100 billion for the first time. In the face of that ramping revenue and the company’s AI infrastructure scale-up, the Intelligent Cloud operating margin held roughly flat at 41%. We read that as better than feared, especially when viewed against Meta’s margins.

Microsoft 365 Copilot reached over 30 million paid seats, more than doubling sequentially.

On a year-over-year basis, commercial RPO grew 84% to $678 billion, but to us the quarter-over-quarter comparison is far more important. On that front it increased more than $50 billion compared to where it was at the end of the March 2026 quarter. While a meaningful chunk of that year-over-year growth was due to OpenAI related commitments, excluding that Microsoft’s RPO still grew a healthy 25%.

About 30% of total RPO, roughly $203 billion, is expected to convert to revenue over the next 12 months and that means another significant jump in Intelligent Cloud segment revenue. For the current quarter, Azure revenue growth is expected to accelerate further, to approximately 45% in constant currency, with the broader Intelligent Cloud segment guided to $40.95 billion-$41.25 billion, up 33%-34%.

That means more capacity will be needed. Before we get to that, though, let’s tackle the “lowering” of Microsoft’s capex for this year. While Microsoft lowered its reported calendar 2026 capital spending forecast to roughly $175 billion from $190 billion, that drop is largely due to an accounting change. What’s going on is Microsoft is extending the estimated useful life of its data centers and office buildings from 15 years to 25 years, effective at the start of fiscal 2027, which began at the start of July.

Here’s the thing, after spending $72.9 billion in capex in the first half of calendar 2026, the company’s guidance points to $100 billion being spent in the next two quarters. That fleshes out the bullish comments we made in our Meta note for Marvell (MRVL) and Arista Networks (ANET), but also Broadcom (AVGO), Nvidia (NVDA), Eaton (ETN) and Applied Materials (AMAT).

While both Meta and Microsoft are spending more in the coming quarters, with both telegraphing even higher spending in 2027, the difference is that Microsoft generated $55.4 billion in operating cash and $19.6 billion in free cash in the June 2026 quarter. That operating cash figure was up 30% sequentially, while the free cash flow figure reflected the uptick in capital spending in the June quarter.

Given the spending that is expected to happen, Microsoft management made sure to say it expects to remain free-cash-flow positive over the coming 12 months, in other words, fiscal year 2027. What they did not mention was a targeted number, which reading between the lines means we should expect further free cash flow compression as spending ramps into the back half of calendar 2026 and beyond. What the team is likely looking to avoid is the market reaction to the air-pocket we just saw in Meta’s own free cash flow numbers.

Microsoft’s margin guidance also suggests it will continue to manage the impact of that ramping capacity. For fiscal 2027, the team guided to full-year operating margin down less than a point, which tells us the AI infrastructure drag on gross margin is expected to persist, but the operating leverage story — double-digit revenue growth in the coming year vs. mid-to-high-single-digit opex growth — should keep operating margin roughly stable rather than eroding.

Our Takeaway, Rating and Potential Pickup Points

We’d sum up our key takeaway as Microsoft giving the market a reason to become more comfortable with the AI-spending story. Revenue growth is accelerating, margins are holding up, RPO gives real visibility into that growth, and capex is rising but fundable primarily from operating cash flow. That separates Microsoft from others in the pack, but the long-term play with it is the same as the others — waiting for when that capex finally translates into durable free cash flow growth rather than just revenue growth.

That likely means MSFT shares will bob and weave in the coming months, and that keeps our Two rating and $500 price target intact for now. In our view, folks interested in picking up MSFT shares should at a minimum wait for the current bout of short-covering to fade and look for a positive test of support levels. The next layer is the 200-day moving average near $433; after that the next stop is near $399, which is where both the 50 and 100-day simple moving averages are.

Connecting a Few More Dots

Before we leave you to get ready for results from Apple (AAPL) and Amazon (AMZN) results after today’s market close, a quick word on Microsoft’s device business, More Personal Computing. Revenue was $12.9 billion in the quarter, down 4%, with Windows OEM and devices revenue falling 7% due to lower PC market demand. Reading between management comments, there still seems to be some inventory stocking in the channel given the increasing component prices for memory and others that we’ve talked about. For the current quarter, Microsoft sees its Windows OEM and devices revenue dropping in the mid-20% amid the current market dynamics.

While we exited our Qualcomm (QCOM) position earliest this year, that comment from Microsoft reaffirms the challenges in Qualcomm’s transformation that led us to close out our position when we did for a hefty gain.

And while that business will be down for Microsoft, let’s remember something we discussed with you months ago: Microsoft today is very different than it was 10-15 years ago. We can see that in the current revenue mix between Intelligent Cloud, Productivity and Business Services, and More Personal Computing, but the real difference is captured in its operating profit dollars. Productivity and Business Services and Intelligent Cloud accounted for almost 91% of total operating profit over the last 12 months.

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At the time of publication, TheStreet Pro was long AAPL, AMZN, ANET, AVGO, ETN, META, MRVL, MSFT and NVDA.