Microsoft Is Striking the Right Balance Between Software and Cloud

Microsoft is in Wall Street’s doghouse. The company’s shares have lagged the S&P 500 index for the past few months, and the big stock sell-off that followed last Wednesday’s earnings report has left them trading at their lowest value, as a multiple of operating profits, since 2022. Investors were responding to a slight slowdown in growth at the company’s closely watched cloud computing business, Azure—but they’re missing the bigger picture.

Azure could have grown faster in the quarter if it had obtained more computing capacity. But Microsoft allocated a big chunk of its computing capacity to serve its enterprise software business instead, Chief Financial Officer Amy Hood told analysts last week. That makes sense: Software is Microsoft’s biggest and most profitable business, with stable gross margins of around 81%. In contrast, margins at Microsoft’s Intelligent Cloud unit—primarily Azure—are about 20 percentage points lower and falling. That means Azure’s growth is putting downward pressure on the company’s margins.