Why has Microsoft stock dropped 28% from its 52-week high?

The decline reflects a broad tech sector correction driven by AI disruption fears, concerns about massive capital expenditure requirements for AI infrastructure, and investor rotation away from megacap growth stocks. Microsoft's spending — over $64 billion in FY2025 capex with further acceleration expected — has raised questions about near-term free cash flow compression, even though the underlying business continues to grow revenue at 16% and expand operating margins.

Is Microsoft's AI investment paying off?

Early signs are positive. Azure AI services are growing at triple-digit rates, Microsoft 365 Copilot is gaining enterprise traction, and the company's $625 billion commercial backlog provides significant revenue visibility. However, the full return on Microsoft's massive AI capex cycle — which could reach $100+ billion annually — won't be fully apparent for 2-3 years. The key metric to watch is whether Azure revenue growth continues accelerating relative to the capex commitment.

What is Microsoft's current valuation compared to historical levels?

At 25.15x trailing earnings, Microsoft trades at its cheapest P/E multiple in over two years and roughly in line with the S&P 500 average — highly unusual for a company growing revenue at 16% with 47% operating margins. The PEG ratio of 0.60x suggests meaningful undervaluation relative to growth. On estimated FY2028 earnings of ~$22 per share, the stock trades at approximately 18x forward earnings.

How strong is Microsoft's balance sheet?

Extremely strong. Microsoft holds $89.5 billion in cash and short-term investments against $57.6 billion in total debt, yielding net debt of just $33.3 billion. The debt-to-equity ratio is a conservative 0.15x, interest coverage exceeds 52x, and the company generated $136.2 billion in operating cash flow in FY2025. Even with surging capex, the balance sheet provides ample capacity for continued investment, dividends, and buybacks.

When does Microsoft report earnings next and what should investors watch?

Microsoft's next earnings report is scheduled for April 29, 2026, covering fiscal Q3 FY2026 (January-March 2026). Key metrics to monitor include Azure revenue growth rates and AI contribution, Copilot adoption metrics and monetization progress, capex guidance for the remainder of the fiscal year, and any commentary on free cash flow trajectory as data center investments ramp.

MSFT Analysis: The Most Under-Owned Megacap ...

Microsoft Corporation (NASDAQ: MSFT) trades at $401.65 as of February 18, 2026 — a striking 28% below its 52-week high of $555.45 and well under both its 50-day moving average of $460.94 and 200-day average of $487.38. For a company generating over $305 billion in trailing twelve-month revenue and posting consistent double-digit growth, the disconnect between fundamentals and price action is notable. Morgan Stanley recently called Microsoft "the most under-owned megacap" on Wall Street, a rare label for a company with a $2.98 trillion market capitalization.

The pullback has been driven by a broader tech sector correction fueled by AI disruption fears and investor concerns about the staggering capital expenditure required to build out generative AI infrastructure. Microsoft pledged $50 billion for Global South AI expansion alone, on top of tens of billions already committed to Azure data centers. Yet the most recent quarter — fiscal Q2 2026 ending December 2025 — delivered $81.3 billion in revenue, a 16% year-over-year increase, with diluted EPS of $5.16 and operating margins expanding to 47.1%. These are not the numbers of a company in crisis.

The central question for investors is whether Microsoft's massive AI capital cycle will generate returns commensurate with the investment, or whether rising depreciation and capex will structurally compress free cash flow. With the stock trading at 25x trailing earnings — its cheapest valuation in over two years — the market appears to be pricing in meaningful risk. This analysis examines whether that risk is adequately rewarded.

Valuation: A Rare Discount for a Rare Business

Microsoft trades at a trailing P/E of 25.15x on EPS of $15.97, a significant compression from the 34-35x multiples it commanded as recently as September 2025. The price-to-book ratio has declined from 10.8x to 9.2x over the same period, while the enterprise value-to-EBITDA multiple for the most recent quarter stands at 62.3x on a single-quarter annualized basis — though on a trailing twelve-month basis, using roughly $191 billion in combined EBITDA, the multiple is closer to 19x.

For context, the S&P 500 trades at approximately 21-22x forward earnings, meaning Microsoft is trading roughly in line with the broader market despite growing revenue at 16% and possessing arguably the strongest competitive position in enterprise technology. The PEG ratio of 0.60x based on recent growth rates suggests the stock is meaningfully undervalued relative to its earnings growth trajectory.

The earnings yield of 4.0% compares favorably to risk-free rates, and Microsoft's dividend yield of 0.19% — while modest — is supplemented by consistent share repurchases ($18.4 billion in FY2025). The Graham Number of $78.26 is well below the current price, but this metric systematically undervalues asset-light, high-ROE technology businesses. By any reasonable DCF framework assuming mid-teens revenue growth and gradual margin recovery, Microsoft's intrinsic value likely exceeds $480-520 per share.

MSFT Valuation Multiple Compression (P/E Ratio by Quarter)

Earnings Performance: Accelerating Revenue, Expanding Margins

Microsoft's last four quarters reveal a business firing on all cylinders. Revenue has climbed sequentially from $70.1 billion (Q3 FY25) to $76.4 billion (Q4 FY25), $77.7 billion (Q1 FY26), and $81.3 billion (Q2 FY26) — representing a trailing twelve-month total of $305.5 billion. The Q2 FY26 result of $81.3 billion marks the company's highest quarterly revenue ever, driven by surging Azure cloud and AI services demand.

Gross margins have remained remarkably stable in the 68-69% range, even as Microsoft absorbs massive infrastructure costs. More impressively, operating margins have expanded from 45.7% in Q3 FY25 to 47.1% in Q2 FY26, indicating that revenue growth is outpacing cost increases. The operating income of $38.3 billion in the most recent quarter translates to an annualized run rate exceeding $150 billion.

Diluted EPS tells a compelling story: $3.46 in Q3 FY25, $3.65 in Q4 FY25, $3.72 in Q1 FY26, and $5.16 in Q2 FY26. The Q2 spike to $5.16 was boosted by a $10 billion gain in other income (likely investment gains), but even the underlying operating trend shows consistent improvement. Net income for Q2 FY26 reached $38.5 billion — a net margin of 47.3% that is extraordinary for a company of this scale.

MSFT Quarterly Revenue & Operating Income ($B)

Financial Health: A Fortress Balance Sheet Under Capex Pressure

Microsoft's balance sheet remains one of the strongest in corporate America, but the AI infrastructure buildout is reshaping its financial profile in important ways. Total assets have grown from $562.6 billion in March 2025 to $665.3 billion by December 2025, driven primarily by a $78 billion increase in property, plant, and equipment — from $208.4 billion to $286.2 billion. This reflects the unprecedented scale of data center construction.

Cash and short-term investments totaled $89.5 billion at quarter-end, down from $102 billion in the prior quarter but still substantial. Total debt stands at $57.6 billion, yielding a very conservative debt-to-equity ratio of just 0.15x and net debt of $33.3 billion. The net debt-to-EBITDA ratio of 0.57x provides ample headroom for continued investment. The current ratio of 1.39x indicates healthy liquidity, and interest coverage at 52x means debt service is trivial relative to earnings.

The critical concern is free cash flow. FY2025 (ending June 2025) generated $136.2 billion in operating cash flow — up 15% from $118.5 billion in FY2024 — but capital expenditures surged to $64.6 billion from $44.5 billion, leaving free cash flow at $71.6 billion, down from $74.1 billion the prior year. In Q2 FY26, capex consumed 83.6% of operating cash flow, leaving just $5.9 billion in free cash flow — the thinnest margin in years. The capex-to-depreciation ratio of 3.25x in Q2 FY26 confirms that Microsoft is investing far faster than its existing assets are depreciating, which will create a rising depreciation headwind for years to come.

Annual Free Cash Flow vs. Capital Expenditure ($B)

Growth and Competitive Position: The AI Platform Advantage

Microsoft occupies a uniquely advantaged position in the AI era, functioning simultaneously as infrastructure provider (Azure), application layer (Microsoft 365 Copilot, GitHub Copilot), and platform enabler (OpenAI partnership). This vertical integration across the AI stack is unmatched by any competitor.

Azure remains the primary growth engine, with the cloud platform's AI services contributing an accelerating share of revenue. Zacks Research highlighted Microsoft's $625 billion backlog and 47% operating margins as key differentiators versus Oracle and other cloud competitors. The CrowdStrike Falcon platform's addition to Microsoft Marketplace — announced today — exemplifies how Azure's ecosystem flywheel continues to attract third-party workloads, deepening customer lock-in through Azure Consumption Commitments.

Microsoft's competitive moat extends across multiple dimensions. In enterprise productivity, Microsoft 365 commands roughly 50% market share with deep workflow integration. In cloud infrastructure, Azure holds approximately 25% of the market — second only to AWS — with the fastest growth rate among hyperscalers. In developer tools, GitHub (with 100+ million developers) and Visual Studio create powerful switching costs. And the OpenAI partnership provides preferential access to frontier AI models that competitors cannot replicate.

However, risks exist. Microsoft President Brad Smith acknowledged today that U.S. tech companies should "worry a little" about Chinese government subsidies supporting AI competitors. The broader AI disruption narrative has already pressured software stocks, as investors question whether AI agents could commoditize traditional SaaS revenue. Microsoft's response — embedding Copilot across every product — appears sound but remains unproven at scale.

Forward Outlook: Analyst Estimates and Catalysts

Analyst consensus estimates project robust continued growth. For the quarter ending September 2027, analysts expect revenue of approximately $101.8 billion (versus $77.7 billion in the year-ago period, implying 31% growth) with EPS of $5.27. For the December 2027 quarter, estimates rise to $106.3 billion in revenue and EPS of $5.41. Looking further out to FY2028, consensus points to quarterly revenue exceeding $115 billion with EPS approaching $5.89 — suggesting annualized earnings power of roughly $22 per share, which would place the stock at just 18x forward earnings two years out.

While specific analyst price target consensus data was unavailable, Morgan Stanley's recent characterization of MSFT as "the most under-owned megacap" suggests significant institutional conviction that the stock is mispriced. The 28% decline from highs has created a valuation floor that is historically unusual for Microsoft outside of broad market corrections.

Key catalysts in the near term include: (1) the next earnings report on April 29, 2026, which will provide updated Azure growth metrics and Copilot monetization data; (2) further evidence of AI workload ramp translating into revenue acceleration; (3) potential moderation in capex growth as the initial infrastructure buildout matures; and (4) the $50 billion Global South AI expansion commitment, which opens massive new addressable markets.

Risks to monitor include: rising depreciation expense compressing margins as data center assets come online, potential regulatory scrutiny of the OpenAI relationship, macroeconomic slowdown reducing enterprise IT spending, and competitive pressure from Google Cloud and AWS in AI infrastructure. The stock's below-average trading volume (11 million shares vs. 31 million average) on today's +1.2% session suggests institutional repositioning is still in early stages.

The Capex Conundrum: Investment Cycle or Margin Trap?

The single most important debate around Microsoft's stock centers on the trajectory of capital expenditure and its impact on future returns. FY2025 capex of $64.6 billion was nearly triple FY2022 levels ($23.9 billion), and the Q2 FY26 run-rate of approximately $30 billion per quarter suggests FY2026 capex could approach $100-120 billion. Microsoft's pledge of $50 billion for Global South AI infrastructure alone through 2030 adds further visibility to spending.

Bulls argue this is a generational investment cycle with clear return potential. Azure AI revenue is growing at triple-digit rates, Microsoft 365 Copilot is still in early innings of enterprise adoption, and the total addressable market for AI-driven enterprise software is measured in trillions. Historical parallels to Amazon's AWS buildout — where years of heavy capex produced the world's most profitable cloud business — support this thesis.

Bears counter that the capex-to-depreciation ratio of 3.25x means depreciation charges will mechanically rise for years, creating an earnings headwind even if revenue growth remains strong. Free cash flow conversion has already deteriorated — Q2 FY26 FCF was just 16.4% of operating cash flow, down from 57-60% in prior quarters. If AI revenue growth disappoints or competition intensifies, the fixed cost base created by this infrastructure could permanently impair returns.

Microsoft's commitment to matching 100% of its electricity consumption with renewable energy purchases — a milestone achieved for the first time last year — adds an ESG dimension but also additional cost. The truth likely lies between the extremes: capex will moderate as the initial buildout peaks, depreciation will pressure margins near-term but be absorbed by revenue scale, and Microsoft's platform breadth gives it more vectors for AI monetization than any single-product competitor.

Conclusion

Microsoft at $401.65 represents a compelling risk-reward proposition for long-term investors. The stock trades at 25x trailing earnings and roughly 18x estimated FY2028 earnings — a valuation that prices in meaningful capex risk while offering substantial upside if AI monetization scales as management projects. The balance sheet is fortress-grade, the competitive moat spans infrastructure, applications, and developer ecosystems, and revenue growth of 16% for a $3 trillion company is remarkable.

The bull case is straightforward: Microsoft is the operating system of the AI era, generating $305 billion in annual revenue with expanding margins, and the current pullback offers an entry point 28% below recent highs. A return to 30x forward earnings on $22 in estimated FY2028 EPS implies a price target of $660 — 64% upside. The bear case centers on capex overshoot, margin compression from rising depreciation, and the risk that AI-driven productivity gains cannibalize traditional software revenue faster than new AI revenue scales.

For portfolio construction, MSFT is a core holding appropriate for investors with a 3-5 year time horizon who can tolerate continued volatility as the AI investment cycle plays out. Accumulating on weakness below $400 offers an attractive margin of safety, while those already holding should resist the urge to sell into the pullback. At current levels, Microsoft offers the rare combination of quality, growth, and value — a setup the market seldom provides for a business of this caliber.