Key Points
Microsoft beat on sales and earnings last night.
Investors may be more worried about Microsoft's free cash flow -- which is falling.
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Microsoft (NASDAQ: MSFT) stock fell 4.6% through 11:15 a.m. ET Thursday despite beating on both top and bottom lines in its fiscal Q3 2026 earnings report last night. Heading into the report, analysts forecast Microsoft to earn $4.05 per share on sales of $81.3 billion. In fact, Microsoft earned $4.27 per share on sales of $82.9 billion.
So what went wrong?
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Image source: Microsoft.
Microsoft Q3 earnings
At first glance, very little went wrong for Microsoft in Q3. Sales surged 18% year over year, and both operating and net profit grew even more strongly, up 20% and 23%, respectively. Earnings per share likewise grew 23%, in line with net profit, indicating minimal stock dilution. Sales at the company's growing artificial intelligence division more than doubled, up 123% year over year to $37 billion.
Yes, you read that right. Microsoft today already gets nearly half its revenue from AI -- but that's bad news as well as good.
Microsoft's big AI problem
Heavy investment "delivering cloud and AI infrastructure and solutions that empower every business to eval-max their outcomes in the agentic computing era," as CEO Satya Nadella put it, is driving AI revenue for Microsoft. But this comes at a cost. Microsoft generated $46.7 billion in operating cash flow in Q3 -- then spent $30.9 billion of that on capital investment.
This reduced free cash flow for the quarter to $15.8 billion, a 22% decline from last year's Q3.
Year-to-date, Microsoft has generated $47.4 billion in positive free cash flow, much less than its reported $98 billion net profit. On course to generate perhaps $63.2 billion in FCF this year, this would value the $3.2 trillion stock at a heady 50x FCF.
Even with 23% growth, that's a high price to pay.
Should you buy stock in Microsoft right now?
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
