Microsoft’s Worst Start Since 2008. Should You Buy the Dip?

The entire software sector is going through a tough time, and Microsoft (NASDAQ:MSFT | MSFT Price Prediction) is one of the worst victims at the moment. MSFT’s downturn is not due to a single reason and is more multifaceted. The biggest trigger was Microsoft’s earnings on January 28, where the stock fell despite it posting an earnings beat.

It’s not that paradoxical when you take into account how the broader market is viewing software and AI. Most investors are no longer willing to pay increasingly higher and higher premiums for AI stocks and are instead waiting it out. If anything, AI is becoming a warning signal instead of a magnet for investors. A large portion of the market now believes an AI bubble burst is inevitable, and they’re quickly shifting towards dividend stocks by abandoning software names.

Microsoft is one of them, and the problem runs quite deep.

So, is MSFT stock worth buying the dip on? Let’s first take a deeper look at what’s going on.

Investors don’t like the AI spending

While investors do like the revenue and bottom-line growth, AI hasn’t dramatically changed the trajectory the company is on. Growth has been on the current trajectory since 2019, though whether or not the massive cost is worth it is driving the narrative.

Intelligent Cloud and Productivity and Business Processes are the two segments driving the most growth right now. Intelligent Cloud is where Microsoft Azure resides and is what investors are paying attention to. Most of the big-ticket spending is also going there, as Microsoft expects Azure to see more demand and hence is building out significant data center capacity.

The problem is, many investors don’t think the demand will go up in an accelerating fashion and could stagnate or come down if the AI narrative implodes.

Intelligent Cloud revenue went up from $18.2 billion in 2021 to $32.9 billion in 2025, which is great, but not when you factor in the fact that capital expenditure has surged from $20.6 billion in 2021 to $64.6 billion in the same timeframe.

In fact, the extreme spending is already affecting the balance sheet.

This isn’t a buy signal for the market. The share buyback ratio has also dropped from 2.73% in 2016 and is now flat.

Is AI hurting Microsoft?

There’s an argument to be made that Microsoft is being hurt by AI, instead of benefiting from it. That might sound crazy until you look at the company’s cash flow metrics and realize that the earlier growth trajectory was still strong enough without AI.

Free cash flow abruptly started going sideways after 2022, precisely because Microsoft entered a spending war with other AI companies. You likely remember that promise by Microsoft to spend $80 billion last year. Back then, it was hugely positive, as Microsoft made it clear that AI was theirs to dominate.

A year out, however, one can confidently argue that Microsoft is not materially any closer to dominating AI. In fact, it is lagging behind.

Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), and Amazon (NASDAQ:AMZN), two of Microsoft’s biggest competitors, are ahead when it comes to AI. Google has been dominating as it pertains to AI models, with Gemini models leading the benchmarks, and Google’s AI labs consistently competing with the top private AI companies.

Amazon’s AWS is speeding up again, and it does not look like Azure is set to surpass it anytime soon. Worse, Amazon-backed Anthropic is set to become profitable and has positioned itself as the best AI company for programming. On the other hand, Microsoft’s investments in OpenAI are yet to bear fruit directly.

Microsoft might have to slam the brakes

The excessive focus on it is harming the company in other ways, too. Windows 11’s AI integrations are now irritating many users, who see it as too intrusive. These users are shifting to other operating systems like Linux, which has been made far more accessible due to AI itself. Few people are actually using Microsoft’s Copilot.

And if you look at the hardware side, the spending isn’t going into things that last, either. In fiscal Q2 2026, Microsoft spent $37.5 billion on capital expenditures, and roughly two-thirds of that went to short-lived assets such as GPUs and CPUs.

“One big obvious issue is ​that revenues are up 17% and the cost of revenues are up 19%. So if that is a new long-term trend, that is one of my concerns,” said Eric Clark, portfolio manager of the LOGO ETF.

This cost of revenue figure is indeed quite worrying. A large part of this spending sits on a faster replacement cycle. If you cannot show operating leverage while AI demand is hottest and customers are capacity-constrained, then the burden of proof becomes much heavier later.

If Microsoft cannot produce better cost discipline after capacity catches up and the tech matures, then this cycle will be remembered as overbuilding rather than visionary investment.

Why I wouldn’t buy the dip right now

The software industry as a whole may take longer than expected to recover from this, as high oil prices and other structural problems can make 2026 end up looking like a repeat of 2022.

Obviously, MSFT stock looks beyond cheap at 21 times forward earnings, but that’s unfortunately a misleading metric.

It’s time to look at price-to-free-cash-flow, and this is where MSFT stock actually looks a little pricey.

MSFT stock trades at nearly 38 times free cash flow. Historically, MSFT stock has traded at 33 times FCF. Unless Microsoft slows down the spending or at least gets the cost of revenue down, it can get uglier.