Underestimating the inflection point of Azure and Copilot! Morgan Stanley: The market giving Microsoft only a "16x PE" is too low

Morgan Stanley believes Microsoft is at a key inflection point in the AI monetization cycle, while the market appears to have yet to fully price in this opportunity.

According to Chasing Trends Trading Desk news, on July 21, the Adam Wood team at Morgan Stanley published a research report, stating that Microsoft Azure's cloud business is about to enter an accelerated growth phase, and Copilot's commercialization path is evolving from a single seat-based fee into a three-pronged expansion opportunity.

The report notes that calculating the current share price, the implied price-to-earnings ratio (PE) is only about 16x; yet for a tech giant with expected profit growth exceeding 20%, a 16x PE clearly undervalues its intrinsic worth.

Although Morgan Stanley recently lowered Microsoft's 12–18 month target price from $650 to $600 due to concerns over gross margin pressure, increased capital expenditures, and rising debt, they maintain an "Overweight" rating, with the current share price still implying about 50% upside.

Simply put, "16x PE" means the market is currently heavily undervaluing Microsoft.

This figure is calculated by dividing Microsoft’s current share price of $402.29 by Morgan Stanley’s forecasted FY2028 earnings per share of $23.86.

In US equity valuation logic, a reasonable PE ratio usually matches the company's earnings growth rate—the PEG should equal 1.

Microsoft’s forecasted growth for FY2028 is as high as 21.6%; under normal circumstances, it should be entitled to a PE of at least 21x. For similar large-cap software companies, due to their visibility, the market has even granted a PEG of 1.4, equivalent to magnifying the 21.6% growth rate to about a 30x PE.

In contrast, the market is only giving Microsoft a forward PE of less than 17x, meaning you’re buying a high-growth giant growing over 20% annually at the valuation of a slow-growth company.

Morgan Stanley believes there is a clear mismatch in this valuation logic. If re-assessing conservatively at a PEG of 1.2, below peers (corresponding to about 25x PE), and using the FY2028 EPS forecast of $23.86 times 25x PE, Microsoft’s reasonable target price should be around $600.

Improved expectations for Azure growth is one of the key catalysts for Morgan Stanley's bullishness on Microsoft.

(Microsoft Azure AI monetization model)

Over the past year, Azure's growth was bottlenecked by supply constraints. Microsoft management continuously emphasized that customer demand has consistently outstripped available capacity, and the company has also needed to balance compute allocation among external Azure customers, first-party applications (like Copilot), and internal R&D needs.

Microsoft CFO Amy Hood once disclosed on the F2Q26 earnings call that if all the new GPUs launched in Q1 and Q2 were allocated to Azure, that quarter’s Azure growth rate would have exceeded 40%, not the announced 38% (at constant currency).

As new capacity gradually comes online, Morgan Stanley believes these supply constraints will ease and Azure growth is likely to accelerate sustainably.

Management has already provided guidance for a sequential acceleration in Azure growth in the second half of 2026 compared to the first half, with a high degree of confidence.

Morgan Stanley has thus raised its Azure revenue forecasts, projecting revenue from Azure and other cloud services to reach $214.9 billion in FY28 and $305.9 billion in FY29, 5% and 7.8% higher than consensus estimates, respectively.

(Morgan Stanley raises Azure revenue forecasts for the coming years)

Analysts believe the market has underestimated the extent and sustainability of this Azure acceleration. Historically, pent-up constrained demand, once capacity is unlocked, tends to drive growth above expectations and sustain it for a longer period.

The monetization logic of Copilot is undergoing a structural shift, which Morgan Stanley regards as one of the most significant ARPU (Average Revenue Per User) expansion opportunities in Microsoft's history.

Over the past year, the main questions for Copilot have revolved around product-market fit and whether enterprise deployments at scale are feasible. Now, the discussion has shifted to commercialization paths and the long-term revenue magnitude.

Morgan Stanley summarizes Copilot-driven ARPU growth into three main engines:

• First, M365 Copilot direct seat expansion;
• Second, enterprise customers migrating to higher-value M365 E7 subscriptions;
• Third, consumption-based monetization models such as AI Agents and workflow automation.

The launch of the E7 SKU is a core milestone in this strategic evolution. E7 bundles E5, Copilot, and Agent365 together, similar to the previous wave when customers upgraded from E3 to E5. This is likely to kick off a new multi-year enterprise software upgrade cycle, lifting both ARPU and Copilot penetration rates.

Morgan Stanley’s latest CIO survey shows that currently 47% of enterprises are using E5 licenses, and 7% are using E7; in the next year, anticipated migration to E5 and E7 will reach 50% and 21%, respectively.

(Morgan Stanley expects next year’s E5 and E7 subscription rates to reach 50% and 21%, respectively)

From the demand side, 88% of CIOs in Morgan Stanley’s latest survey said they will deploy M365 Copilot in the next 12 months, a significant increase from 80% in the previous Q4 FY25 survey and 72% a year earlier.

(88% of CIOs expect to use Microsoft 365 Copilot within the next 12 months)

As such, Morgan Stanley has significantly raised its Copilot forecasts: FY26 Copilot revenue is estimated at $4.4 billion, rising to about $22.5 billion in FY29.

Gross margin is one of the most common concerns about Microsoft, but Morgan Stanley believes this concern is overplayed.

The firm has trimmed its gross margin forecasts for FY27–FY29 to 65.7%, 64.4%, and 63.4%, mainly due to: rising proportion of Azure AI and Copilot revenue, higher AI-related depreciation, and the front-loading of costs during major infrastructure build-outs.

However, Morgan Stanley also notes that sustained control of operating expenses should offset gross margin pressure, enabling operating profit and EPS growth to remain above 20%. Operating profit margin forecasts for FY27–FY29 are 46.5%, 46.7%, and 47.2%, showing a modest expansion trend.

Historical precedent also supports this view. During the FY14 peak build-out, Microsoft Cloud's gross margin once went negative, but as capacity utilization improved, software efficiency increased, and scale effects played out, gross margins steadily climbed, exceeding 70% by FY23.

(Azure AI margin performance outpaces Azure during the same period)

CFO Amy Hood has stated several times that current AI business gross margins are significantly better than at the corresponding stage during the cloud transition, and reiterated this during the April 2026 earnings call:

Gross margins in the AI business are better than what we experienced during our cloud transition, and this has always been the case.