Microsoft's ratings downgraded twice within a week, warnings issued over AI-related risks

As Wall Street becomes increasingly cautious about the potential disruption artificial intelligence could bring to software stocks, Microsoft’s shares have been downgraded for the second time in less than a week.

On Monday, Melius Research downgraded Microsoft’s rating from “Buy” to “Hold,” citing concerns over capital expenditures (capex) and Microsoft’s AI products branded under Copilot. Copilot is Microsoft’s main vehicle for selling AI software tools to office workers. Earlier, later last week, Stifel also made a similar downgrade, warning that growth in Microsoft’s Azure cloud computing business may be slowing.

Melius analyst Ben Reitzes wrote in the report: “With products like Anthropic’s Cowork emerging, Microsoft’s powerful 365 suite could face challenges, and it might even have to offer Copilot for free to stay relevant, which would hurt growth and profit margins in its most profitable productivity segment. This reality could also tie up internal resources for Azure, limiting the potential for the business to outperform expectations.”

The downgrade comes as investors grow more uneasy about the long-term outlook for the entire software industry. AI tools from companies like Anthropic are seen as significant disruptive forces and could pose long-term, or even permanent, headwinds to growth. A basket of software stocks from Goldman Sachs has fallen more than 14% since late January.

Despite this, Microsoft’s stock rose as much as 2.4% on Monday but remains more than 24% below its October high last year.

The weak stock performance largely stems from Microsoft’s earnings report earlier this month. Due to concerns from analysts about slowing growth in Azure cloud computing and the company’s massive investments in AI, Microsoft experienced a historic sell-off.

In Reitzes’ view, Microsoft is in a “dilemma”: to catch up with Alphabet and Amazon, the company must significantly increase capital spending, which could again impact free cash flow. But if it doesn’t ramp up investments now, it either indicates execution issues or is aimed at managing earnings—neither of which is good.

Reitzes also expressed concern about whether AI will ultimately deliver returns, saying, “We increasingly believe that paying extra for AI is not a thing. Copilot may have to be bundled for free, which could push up costs in the long run.”

Melius also lowered Microsoft’s target price to $430, one of the lowest on Wall Street.

Despite the downgrade, about 96% of analysts tracked by Bloomberg still recommend buying Microsoft shares, with the rest giving a “Hold” rating, and no analysts recommending a sell. The average target price is slightly above $600, implying nearly 50% upside from the current stock price.

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