Market Cap Increased by $1 Trillion in a Single Quarter: Why Is Microsoft (MSFT.US)‘s AI Story Once Again Being Embraced by the Market?

According to Zhitong Finance App, as the third quarter closed, Microsoft (MSFT.US) recorded its best quarterly stock performance since 1998. From July to September, Microsoft's share price rose by 37.5%, increasing its market capitalization by $1 trillion. In contrast, the tech-heavy Nasdaq 100 Index only rose by 0.4% over the same period, with Microsoft ranking as the fifth-best performing component of the index. Wall Street is betting that as Microsoft's position in the artificial intelligence sector continues to strengthen, its stock is expected to keep rising.

Chad Morganlander, Senior Portfolio Manager at Washington Crossing Advisors and a long-term Microsoft holder, said that after a period of unclear messaging, Microsoft has become clearer and more concise in how it will monetize capital expenditures and benefit customers.

Microsoft's latest rally largely stemmed from the earnings report released at the end of July. The report showed that, driven by strong AI demand, Microsoft Cloud achieved its fastest growth in four years. The day after the earnings release, Microsoft's stock jumped 16%, marking its best single-day performance since October 2008, with a market capitalization increase of $450 billion. This earnings report eased market concerns about whether Microsoft's massive AI investments could generate better growth. Compared to other companies also heavily investing in AI, such as Alphabet, Amazon, and Meta, Microsoft's financial performance was more encouraging—it was the only company among the four to have not turned negative in annual free cash flow.

Morganlander stated: "Microsoft has demonstrated a clear path to AI profitability. As a company that continues to invest without falling into losses, it looks like the most mature one in the room."

The strong rebound of Microsoft's stock is particularly notable due to the rapid reversal in market sentiment. June was Microsoft's worst-performing month since 2000, when investors questioned the company's spending and the overall prospects for software companies in an AI-driven world. But since then, industry concerns have eased, and investors have been encouraged by Microsoft's efforts to turn Copilot AI assistant into a product for enterprise customers. Morganlander said: "There are still concerns about the so-called 'SaaS doomsday,' but Microsoft seems less affected by these issues. Meanwhile, the adoption and integration of Copilot has left a strong impression."

However, despite this quarter's rally pushing Microsoft into positive territory for the year, its year-to-date gain of 6.1% still significantly lags the Nasdaq 100 Index's 20% increase. JoAnne Feeney, Portfolio Manager at Advisors Capital Management, said: "The sharp gain this quarter was due to a mistake. Investors realized they misunderstood the company's potential, so much of the rally was merely a correction of that error."

Even so, the growing optimism has made Microsoft a Wall Street favorite. In terms of analysts' ratings, only three have not awarded a "buy" rating, and none have a "sell" rating. Analysts' average target price suggests Microsoft's stock will rise about 11% over the next 12 months. Last week, Stifel upgraded Microsoft to "buy," with analyst Brad Reback stating that Microsoft has "clearly reached an inflection point" and believes the stock's momentum should continue in the second half of the year. He is "increasingly confident in the company's ability to maintain mid- to high-teens revenue growth."

Morgan Stanley's Adam Wood expects Microsoft's total return over the next year to be around 20%, citing its long-term growth potential and the company’s recent decision to raise its dividend. In his September 16 report, he wrote: "Coupled with high double-digit earnings per share growth, this supports Microsoft's sustained, high double-digit total returns, creating an attractive risk-reward profile."

In terms of earnings expectations, Microsoft's revenue for fiscal year 2027 is expected to grow by 18%, roughly in line with fiscal year 2026; Wall Street expects the revenue growth rate to reach 21% in fiscal year 2029. As for earnings per share, growth this fiscal year is expected to be about 11%, lower than the nearly 32% growth in fiscal year 2026, but is projected to reach close to 19% in fiscal year 2028 and 21% in 2029.

Regarding valuation, Microsoft shares trade at about 25 times expected earnings for the next 12 months, which is not cheap, but below its 10-year average of 27 times. Among the largest tech stocks by market capitalization, only Apple is valued higher. Feeney noted: "Some people want to see more Copilot adoption or more features, but the adoption momentum continues to accelerate, and some recent announcements have been very positive. However, Microsoft still needs to continue delivering results."