Microsoft's AI Run: What Was Priced In and What's Left?

The market's reaction to Microsoft's fiscal fourth-quarter report was a classic case of expectations being met, but not exceeded in a way that justified a sustained rally. The numbers themselves were strong: revenue hit $76.44 billion, beating the $73.81 billion consensus, while earnings per share came in at $3.65 versus the $3.37 expected. Yet the stock's immediate 9% pop in extended trading was a textbook "buy the rumor" move, not a signal that the core AI growth story was still a major surprise.

The real positive surprise was in the forward view. Management's guidance for the new fiscal year pointed to 37% constant-currency Azure growth, a clear beat against the Street's 33.7% consensus. That's the kind of acceleration that typically fuels a multi-day rally. But the setup here is different. The AI-driven growth trajectory was already largely priced in, as evidenced by the stock trading near a record. The beat-and-raise on Azure was the expected next step, not a new catalyst.

This frames the new investment question. With the core growth narrative now validated, the focus has decisively shifted to the cost side. The guidance for over $30 billion in capital expenditures for the first quarter alone-far above the $24.23 billion expected-signals that the spending ramp is accelerating, not slowing. The market's initial pop suggests it's still willing to pay for this growth, but the expectation gap has narrowed. The next move will hinge on whether Microsoft can manage this massive investment efficiently, turning its AI bets into profit without a corresponding margin squeeze.

The Rising Cost of the AI Bet: CAPEX and Margins

The market's initial relief after the earnings pop has quickly given way to a sharper focus on the financial trade-off. Microsoft's explosive growth is now being paid for with an equally explosive capital bill. The company spent $34.9 billion in capital expenditures during the quarter, a figure that not only cleared its earlier guidance but significantly exceeded it. This wasn't just a beat; it was a signal that the spending ramp is accelerating faster than even the most optimistic forecasts.

The critical detail investors are now dissecting is the composition of that spending. Nearly half of the $34.9 billion was directed toward short-lived assets like GPUs and CPUs. These are the essential, but rapidly depreciating, computational engines for AI. This raises a fundamental question about the long-term value of that investment. While the other half went toward data centers and infrastructure with decades-long lifespans, the sheer scale of spending on quickly obsolete hardware amplifies concerns about margin sustainability and the potential for a bubble if returns don't materialize quickly enough.

This spending surge is already reflected in the forward view. Management's implied operating margin for the quarter came in at 46.6%, a wide beat against the 45.7% consensus. On the surface, that's a positive surprise, suggesting pricing power and efficiency. But in the context of ballooning CAPEX, it's a figure under new scrutiny. The market is now asking whether this high margin can be maintained when the company is committing over $30 billion in a single quarter just to keep up with demand. The guidance for continued spending growth in fiscal 2026 means the pressure on future margins is not a distant threat-it's the next quarter's reality check.

The bottom line is that the expectation gap has shifted. The AI growth story was largely priced in. Now, the market is pricing in the cost of that growth. The sustainability of those margins, and the return on those short-lived assets, will determine if Microsoft's AI bet pays off or becomes a costly overhang.

Valuation and the Path Forward: Beyond the Hype

The market's verdict on Microsoft's AI story is now a clear vote of "so far, so good" rather than "this is a once-in-a-generation opportunity." The stock's performance this year tells the tale. While Microsoft shares are up about 16.65% in 2025, that trails the S&P 500's 17.67% gain and significantly underperforms AI peers like Nvidia, up 36%, and Alphabet, 64%. This isn't just a minor lag; it's a signal that investors are rotating out of the most expensive Big Tech names, a trend that saw Microsoft touch a six-month low earlier this month.

The stock's pullback from its all-time high of about $555 in late July is the technical manifestation of this rotation. After a powerful run fueled by the AI narrative, the market is now weighing the hype against the emerging fundamentals of cost and execution. The setup is classic expectation arbitrage: the initial "buy the rumor" phase for AI growth has passed, and the stock is now in a "sell the news" or "wait and see" phase.

The key watchpoints for the path forward are now clear. First is the sustainability of Azure's growth. The company's guidance for slightly softer revenue growth in the current quarter, with a top-line range implying 14%-16% growth, marks a deceleration from the 34%+ pace seen last quarter. The market will scrutinize whether this is a natural cooling or an early sign of saturation. Second is the relentless pressure on margins from ballooning capital expenditures. With nearly half of the $34.9 billion in quarterly CAPEX going to short-lived assets like GPUs, the return on that investment is the critical unknown. Can Microsoft maintain its high operating margin while spending at this rate? Finally, execution on new AI infrastructure deals is paramount. The company's 27% stake in OpenAI and its role as a cloud host for AI apps provide a strong foundation, but the next wave of growth will depend on converting its massive infrastructure build-out into tangible, profitable revenue streams.

The bottom line is that Microsoft's valuation is no longer a bet on AI potential alone. It's a bet on execution. The stock's underperformance relative to peers and its pullback from the highs show the market is demanding proof that the company can manage this massive investment efficiently. The hype has been priced in; now, the fundamentals must deliver.