Microsoft Earns 31% More Than It Did a Year Ago and Is Worth Less

Microsoft (NASDAQ:MSFT) has just reported what was possibly one of the best years in its history. In fiscal 2026 (the year ended June 30), revenue rose 18% to $331.8 billion, and net income grew 31% to $133.7 billion.

The stock, however, did not follow the same path. Microsoft's market cap, at about $3.59 trillion as of this writing, sits about 4.5% below where it was a year ago.

How did this happen? The market put a different price on earnings. A year ago, investors paid about 37 times earnings for Microsoft. Today they pay about 27 times earnings.

Put another way, the business grew nearly a third, yet the price of each dollar of its earnings fell more or less by the same proportion.

So, exactly what did the market stop paying for?

The business did its part

Whatever the answer, it is not headline results. Revenue growth held at 18% for the full year and again at 18% in the fourth quarter. Azure revenue topped $100 billion for the fiscal year, up 41%, and fourth-quarter revenue from Azure and other cloud services grew 43%. Commercial remaining performance obligation (contracted work not yet recognized as revenue) hit $678 billion, up 84% year over year. Operating income rose 21% to $155.2 billion, faster than revenue.

To be fair, gains from Microsoft's investments in OpenAI added about $5 billion to fiscal 2026 net income, which boosts that 31% figure. Excluding the impact of OpenAI, earnings per share still rose 22% -- although even that figure includes a $3.2 billion gain in the fourth quarter from Microsoft's stake in Anthropic.

Still, a business of this size growing at those rates year after year would normally command a higher price, not a cheaper one.

What gives?

Software stocks have fallen broadly this year on fears of disruption from generative artificial intelligence (AI) models -- and Microsoft has been caught in that decline.

The underlying spending

But I think the bigger and more specific concern lies in the company's cash flow position.

Microsoft spent $115.9 billion on property and equipment in fiscal 2026, up 80% from the $64.6 billion the prior year. In the fourth quarter alone, capital expenditures and finance leases hit $41 billion, up 69% year over year. For calendar 2026, chief financial officer Amy Hood has given guidance of about $175 billion in capital expenditures and finance leases, and expects more growth in fiscal 2027, pointing to "demand signals across our portfolio."

Contrast that with what the company earns. In fiscal 2026, the company generated $155.2 billion in operating income. In other words, planned capital expenditures for the year are greater than everything the entire business earned from operations last year.

Sure, operating cash flow rose 34% year over year to $182.9 billion in fiscal 2026 (the business generates money in droves). But after capital expenditures, free cash flow came in at about $67 billion -- below about $72 billion from the prior year.

So, earnings rose 31%. But the leftover cash flow after capital expenditures shrank.

Further, almost every dollar Microsoft spends on data centers returns over time as depreciation that reduces future earnings, and the payoff is uncertain, depending on AI computing demand staying strong enough in a few years to fill the capacity being built today.

Pricing in the doubt

The contrast with Apple (NASDAQ:AAPL) shows how the market is voting. Apple spent $6.8 billion on capital expenditures in the first nine months of its fiscal year (less than what Microsoft spent just in its June quarter), and its market cap rose about a third over the past year, to $4.51 trillion. Apple now trades at about 35 times earnings, versus 27 for Microsoft.

Right now, investors pay a premium for the company that touches the customer and spends the minimum, and a discount for the one that builds the computing layer underneath.

Then there's, of course, the discount the market seems to be assigning many software-centric stocks since it's uncertain how well software will hold up in an AI era. This risk may be the biggest reason Microsoft's stock hasn't kept up with its underlying business performance.

But there's a lot to be excited about.

The $678 billion backlog is demand customers have already contracted for (although Microsoft said in January that about 45% of that figure at the time came from OpenAI alone). And if Azure continues growing at a pace near 40% while spending stabilizes, today's 27 times earnings could look conservative.

Overall, the market seems to be approaching Microsoft stock skeptically but possibly fairly as well. In other words, I think shares are more of a hold than a buy here.

Daniel Sparks and his clients have positions in Apple. The Motley Fool has positions in and recommends Apple and Microsoft. The Motley Fool has a disclosure policy.