Microsoft's hard road ahead

For being a core member of the Mag 7, Microsoft isn’t looking like such a magnificent investment this year.

In the first quarter of the year, Microsoft shares sank 23%—its worst quarter since 2008—and the stock hasn’t budged since. Microsoft’s underperformance comes as the broader Mag 7 club has had a tough start to the year: Overall, the Mag 7 as a group are down over 12%, compared to the S&P 500’s decline of just 3.41%.

The problem, of course, is AI. Goldman Sachs analyst Gabriela Borges laid out the key reasons for Microsoft’s underperformance this year in a research note today:

• Microsoft, like its big tech peers, is splashing out a hefty amount on capex to build out data centers and other AI infrastructure—but in turn, investors expected to see far faster growth in its cloud platform Azure, which hasn’t panned out yet.
• Shareholders have been concerned that other AI tools like ChatGPT and Claude could take market share from Microsoft Office 365 tools like Word and Excel.
• To top it all off, many people aren’t confident Microsoft’s Copilot is as good as other generative AI competitors.

Opening Windows of opportunity

As you already know if you’ve been paying attention, the AI race is a marathon, not a sprint. While it’s lagging the rest of the pack today, Microsoft could be a winner in the long run, according to Goldman Sachs.

“For the stock to begin outperforming we believe two dynamics will be key: a) supply normalizing such that Azure can beat and raise even while Microsoft makes internal investments; b) Copilot datapoints and monetization improving to neutralize the disintermediation bear case,” explained Borges.

That’s all easier said than done, which is why Borges’ short term outlook is more mixed—she notes that Azure doesn’t have the capacity to fully meet demand yet, and data center spending will keep ramping up before investors start to see returns on that investment. But Borges believes that Microsoft will make a major comeback—in fact, the analyst has a Buy rating on Microsoft and a one-year price target of $600, 61% higher than where shares trade today.

To hit that lofty goal, Microsoft will need to increase its AI tab over the next few years. While it’s expected to spend over $108 billion this year, Borges predicts that its capex could reach as high as $200 billion in 2027, and $241 billion in 2028.

On the bright side, Borges argued that fears about Microsoft Office losing steam are already reflected in the stock, and that Copilot will improve with new AI upgrades. She believes that Microsoft actually has an advantage in the AI game, given its tools are already integrated into workplaces everywhere, and people are familiar with the classics like Excel, Word, and PowerPoint.

Then again, if we never saw an Excel spreadsheet for the rest of our lives, you wouldn’t hear us complain.—LB