Microsoft forecast spurs relief rally and shows top companies positioned to weather rising inflation

Published Tue, Jan 25 20229:35 PM EST

Entering its quarterly earnings report on Tuesday, Microsoft 's stock was down 14% in January and headed for its worst month since 2010. Microsoft beat on the top and bottom lines, but investors weren't comforted. The stock fell another 5% in extended trading. It took fiscal third-quarter guidance on the ensuing earnings call and a revenue range that, even on the low end, topped analysts' estimates to calm the nerves of investors. Microsoft executives said demand is solid across the business. The stock finally turned around and pushed into positive territory, rising 1.2% to $292 in after hours Tuesday evening. The skittishness aligns with a broader concern about tech that's sent valuations tumbling in the past two months. Surging inflation and concerns over rising interest rates are having an outsized impact on the sectors that performed the best in recent years. As of the end of last week, 42% of stocks in the Nasdaq had lost at least half their value, as Jason Goepfert of Sundial Capital Research pointed out on Monday. The iShares Expanded Tech-Software Sector ETF is down 25% from the record it reached on Nov. 9, while the Global X Cloud Computing ETF has fallen 31% over that period. Microsoft is in both. It's also in the S & P 500, and has the second-highest weighting, accounting for about 6% of the index. Microsoft has dropped along with the other trillion-dollar tech companies, pulling down the S & P 500. "It basically is the market now," said David Wagner, a portfolio manager at Aptus Capital Advisors, which owns about $38 million in Microsoft stock. Wagner said Microsoft's results and guidance will likely provide some much needed momentum for the market. "The solid and robust Microsoft guide should be front and center tomorrow morning, and that should help calm Wall Street's tech growth worries," he said. Wagner added that Microsoft's report reminds investors that there are two distinct categories in tech: "those with healthy free cash flow and those that are speculative." Microsoft generated $14.48 billion in cash from operations in the quarter. Higher rates won't become a problem for Microsoft and other quality stocks, such as Apple (which reports on Thursday), but companies that are burning cash and were being valued on future profit may still be in trouble, Wagner said, as debt becomes more expensive. On Tuesday, Microsoft executives took numerous opportunities to tout the strength of demand, whether for Azure, high-end Office subscriptions, Windows, Xbox consoles, security software or Power Apps for simplified app development. Azure's revenue increased 46%, below "some bullish whisper numbers at 48%," analysts at Wedbush Securities wrote. But most of the key figures came in above estimates. "We expect our differentiated market position, customer demand for our high value, hybrid and cloud offerings and consistent execution to drive another strong quarter of revenue growth," Amy Hood, Microsoft's finance chief, told analysts. In the Q & A part of the call, the first analyst question was about the impact of the Covid-19 omicron variant and whether the "overall demand environment" has been hurt of late. CEO Satya Nadella responded by saying that Microsoft is positioned to benefit because of its place in the digital economy. "The demand signals we see across the stack from security, to our cloud infrastructure, to business applications and solutions like Teams is very strong, and the other area obviously we're seeing strength is in gaming," he said. At the same time, Microsoft is keeping costs in check, and Hood said she now sees operating margin widening for the full fiscal year, which ends in June. "There's definitely a very competitive talent market, and we are competitive in that talent market and you see it even in our op-ex projections that Amy shared," Nadella said. "We are growing our headcount because we see the opportunity." A day earlier, IBM CEO Arvind Krishna said higher labor costs will likely start to cut into results in the next few quarters. Microsoft took a different tone. "It seems like they've been able to navigate this entire environment, even in a post-Covid world," Wagner said. "These guys are continuing to be able to put the pedal to the metal on that growth." WATCH: This was the smallest beat for Microsoft, says Jefferies analyst Brent Thill

Microsoft CEO Satya Nadella attends the Viva Tech start-up and technology gathering in Paris on May 24, 2018.

Christophe Morin | IP3 | Getty Images

Entering its quarterly earnings report on Tuesday, Microsoft's stock was down 14% in January and headed for its worst month since 2010.