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Strong Microsoft Earnings Lift Markets

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It has been a choppy week for the markets, but they ended strong on Friday, fueled by a better-than-feared inflation report and strong earnings by a Magnificent Seven stock.

On the inflation front, the Personal Consumption Expenditures (PCE) index for March was not as bad as expected, even though it did tick up to 2.7% in March from 2.5% in February. Many had feared the number would be higher, given the first-quarter PCE increase of 3.4% released on Thursday with the GDP report. Nonetheless, the 2.7% reading for March was still higher than the 2.6% rise that economists had expected.

The other bit of good news came from Microsoft (NASDAQ:MSFT), which posted robust fiscal third-quarter earnings for the period that ended March 31.

The combination of these two factors had the markets trending higher on Friday, led by the Nasdaq Composite, which was up more than 300 points or about 2% on Friday morning.

Microsoft scores revenue and earnings beat

In its fiscal third-quarter earnings report released Thursday after the closing bell, Microsoft posted results that easily topped analysts’ estimates. Revenue climbed 17% year over year to $61.9 billion while net income surged 20% to $21.9 billion or $2.94 per share.

The biggest driver of revenue growth for Microsoft was its Intelligent Cloud business, which surged 21% year over year to $26.7 billion. Within this business, server products and cloud services revenue increased 24%, driven by a 31% increase in Azure, its artificial intelligence-fueled cloud segment.

The overall cloud business, which cuts across multiple segments, saw its revenue rise 23% to $35.1 billion, representing about 56% of Microsoft’s total revenue for the quarter. The gross margin in the cloud business was 72%, on par with the previous quarter and the same quarter a year ago.

Revenue in Microsoft’s Productivity and Business Processes segment surged 12% to $19.6 billion, while More Personal Computing revenue jumped 17% to $15.6 billion. Within the PC segment, Windows revenue rose 12%, as did search and advertising sales. Xbox content and services revenue soared 62%, but that was mostly driven by the recent Activision acquisition.

“Microsoft Copilot and Copilot stack — spanning everyday productivity, business process, and developer services, to models, data, and infrastructure — are orchestrating a new era of AI transformation, driving better business outcomes across every role and industry,” said Microsoft Chairman and CEO Satya Nadella on the earnings call.

Nadella added that Azure gained market share in the quarter as more customers used the platform to develop their own AI solutions.

“Our AI innovation continues to build on our strategic partnership with OpenAI. More than 65% of the Fortune 500 now use Azure OpenAI Service,” he added. “Microsoft Copilot and Copilot stack are orchestrating a new era of AI transformation, driving better business outcomes across every role and industry.”

Outlook is better than expected

Microsoft stock traded 3% higher on Friday, with the shares returning roughly 11% year to date.

Investors were no doubt encouraged not only by the results but also by Microsoft’s outlook for fiscal Q4 and the full fiscal year. The company expects revenue of $28.4 billion to $28.7 billion in Intelligent Cloud, which would be up from $24 billion in the same quarter a year ago. The fiscal-Q4 estimate is slightly higher than analysts had estimated.

More specifically, the Azure business is expected to grow its revenue by 30% to 31% in the current quarter, which is also above expectations.

For the full fiscal year, Microsoft expects double-digit revenue and operating income growth, with the operating margin down about one point. Additionally, capital expenditures are expected to be higher for the fiscal year than they were the previous year due to continued investments in cloud and AI infrastructure.

Microsoft received a slew of price-target increases after posting its latest earnings results, and it remains a consensus buy, with an average price target of $475 per share, which would be about 15% higher than the current price.

Trading at around 36 times earnings, Microsoft’s valuation is in a decent range, and with its momentum, it looks like it has some room to run.