Microsoft stock just had its worst day in two years. Is it an immediate purchase?

Microsoft (MSFT 1.55%) fell 6.1% on Thursday, its worst session since October 26, 2022, when the tech giant slipped 7.7%. Even after gaining 1% on Friday, Microsoft is up less than 8% year to date (YTD), well underperforming S&P 50020.1% YTD gain.

Here's why Microsoft's stellar results weren't enough to impress investors, but why the growth stock might still be worth buying.

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A stunning quarter

Compared to the same period last year, Microsoft increased revenue by 16%, operating income by 14% and diluted earnings per share (EPS) by 10%. The company reports its results in three segments: productivity and business processes, intelligent cloud and more personal computing.

Intelligent Cloud includes Azure and other cloud services, server products, GitHub Cloud and more. But Microsoft sometimes talks about the broader Microsoft Cloud, i.e. the Intelligent Cloud segment, as well as other cloud services like the Microsoft 365 Cloud – which technically falls under productivity and business processes.

Microsoft cloud revenue for the quarter was $38.9 billion, up 22%, with a gross margin of 71% – meaning high-margin cloud revenue now accounts for 59% of total revenue. Or even more astonishing: Microsoft Cloud alone generated more revenue this quarter than the entire company did in the same quarter just four years ago.

The growth of Microsoft's cloud products and services has been one of the main reasons the company has been able to rapidly increase its revenue and profits in recent years.

It has also benefited from acquisitions. Activision Blizzard's purchase increased Xbox content and services revenue by 61%. Excluding the acquisition, this item would have increased by only 8%.

Not every business function is running at full speed. For example, Windows products and devices only grew by 2%.

But overall, Microsoft's results were excellent. Rather, it is the company's artificial intelligence (AI) policies and spending habits that have spooked investors.

Put money into AI

In the quarter, Intelligent Cloud revenue grew 20%, and Azure and other cloud services – the fastest-growing part of Microsoft Cloud – grew 33%. However, for the next quarter, Microsoft expects Intelligent Cloud revenue to grow 18% to 20% on a constant currency basis and Azure to grow 31% to 32% – representing a slight slowdown in growth.

Normally, a slowdown of a percentage point or two wouldn't be a big deal, especially given Microsoft's incredible growth in recent years. But the company has spent a lot of money on AI. At present, these investments do not appear to be contributing sufficiently to short-term growth figures.

During the earnings call, management said it is the first cloud to come to market NvidiaBlackwell system with GB200 based AI servers. Microsoft remains a leader in AI investments and has the cash flow to command premium prices for the best of the best.

But the more AI spending increases, the more pressure investors will put on the company to turn that spending into results.

Capital expenditures (capex), including finance leases, were $20 billion in the quarter. That means nearly 30 cents for every dollar of sales goes toward capital expenditures.

Chief Financial Officer Amy Hood said on the earnings call: “Approximately half of our cloud and AI-related spending continues to be on long-lived assets that will support monetization over the next 15 years and beyond. The remaining cloud and AI spending is primarily on servers, both CPUs and GPUs, to serve customers based on demand signals.”

Later in the call, Hood said: “Given our cloud and AI demand signals, we expect capital spending to increase sequentially. As I said last quarter, we will stick with it and adapt as necessary to the demand signals we see.”

In other words, Microsoft is saying that investors should not expect an immediate return on some of its investments, but rather that those investments will set the stage for future growth. And it says it could further accelerate its capital spending.

Microsoft is taking the right steps in the long term

Investors focused on short-term matters might criticize Microsoft for being too enthusiastic about AI and recklessly pouring money into projects. And perhaps in some ways it is. But the company has the resources to take these steps. So it's better to overspend than to underspend and fall behind the competition.

The company has a clean balance sheet with more cash, cash equivalents, and marketable securities than debt. It has an extensive capital return program consisting of dividends and share buybacks. In fiscal 2024, which ended June 30, the company paid down $29.07 billion in debt, spent $21.77 billion on dividends and $17.25 billion on stock repurchases.

It would be a red flag if management were increasing capex at the expense of its capital return program or financial health, but that's simply not the case. The company can afford to invest heavily in AI and is laying the foundation to become a leader in AI for enterprise software and cloud infrastructure.

Alternatively, the company could use its excess cash for mergers and acquisitions (M&A) rather than organic growth. However, since many of the AI ​​investments are essentially product upgrades to existing tools, the company should innovate on its own.

In fact, it can be a red flag when a company, especially a technology company, relies too heavily on mergers and acquisitions. This can be a sign that the company is unable to grow on its own, whether due to poor management, a lack of talent, or a range of products and services that is losing market share to competitors.

For patient investors, Microsoft remains an all-round good buy

The selloff in Microsoft is a buying opportunity for investors who are comfortable with the company's capital allocation strategy. Additionally, management has made it clear that it intends to continue investing heavily in AI, which could impact near-term growth rates. Therefore, investors who believe that spending should be scaled back may decide to sell the stock. And people who want to see more tangible results from AI monetization might want to wait.

With a price-to-earnings ratio of just 33.9, the stock is a low-cost way to gain diversified exposure to AI, cloud, hardware, gaming and more. Despite increased spending, Microsoft is still growing its revenue and earnings per share at double-digit rates. All in all, it remains the complete package of blue-chip growth stocks.