Key Points
On July 29, Microsoft (NASDAQ: MSFT) delivered blowout financial results for the fourth quarter of its fiscal year 2026, which ended June 30. The company’s cloud computing business was perhaps the biggest story. Microsoft Azure posted 43% year-over-year sales growth, compared to 40% in the previous quarter. The best part is that Microsoft’s work in this area should be a meaningful tailwind over the medium term, and the company’s CEO, Satya Nadella, gave investors several reasons why. Let’s look into one thing he said and what it means for the company’s future.
Image source: Microsoft Corporation.
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Doubling down on custom chips
Microsoft offers artificial intelligence (AI) services through its cloud business, including access to Large Language Models, such as those developed by OpenAI — with which it has a close relationship — as well as its own internally developed MAI family of LLMs. The company naturally needs significant computing power to run these models. To that end, it has historically relied on external suppliers, including Nvidia (NASDAQ: NVDA). The semiconductor specialist offers the best (in terms of peak raw performance) and most versatile hardware for training and running AI models.
However, in recent years, Microsoft has leaned more heavily on its custom AI chips, and that decision is having a meaningful impact on the company’s cloud business. According to Nadella, running MAI models on its custom chips yields 40% better performance per watt. That means lower operating costs and, potentially, higher margins for the company’s cloud segment, which is already its main growth driver. If Microsoft doubles down on custom AI chips, we can expect further efficiency gains, leading to stronger revenue and earnings growth over the medium term, assuming sustained demand for its cloud services.
Thankfully, there is some evidence suggesting Microsoft still has plenty of growth runway in this market. For instance, it ended its fiscal year 2026 with a $678 billion cloud backlog, up 84% year over year. And as AI infrastructure spending continues to expand (with some analysts predicting it could hit $1 trillion within three years), the company should be one of the big winners, as it improves the economics of Microsoft Azure thanks to its custom AI chips. It’s no wonder Microsoft’s shares soared following its latest update, but the stock has still lagged broader equities this year. Microsoft is up 5% to date, as of writing, while the S&P 500 has climbed 12%. There is ample upside left ahead for Microsoft.
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Prosper Junior Bakiny has positions in Nvidia. The Motley Fool has positions in and recommends Microsoft and Nvidia. 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.
