The next week will be packed with major US tech companies’ earnings releases, which are expected to garner significant attention as the buzz around Artificial Intelligence (AI) has been the main driver behind the 2023 equity market rally. Microsoft, alongside Alphabet, will be the first to unveil its Q2 financial performance on Tuesday after Wall Street’s closing bell. Will the fundamentals support the exponential rally, or will guidance around AI initiatives steal the limelight?

Stellar quarter leads to record high

After a devastating 2022, the so-called ‘Magnificent 7’ tech giants have exhibited remarkable performance so far in this year. This aggressive rally was fueled by increasing investor interest towards AI-related projects and supported by liquidity injections in March for the avoidance of further collapses within the banking sector.

Of course, Microsoft could not be missing from this list, with its share price surging to a fresh record high on Tuesday, validating once more the resilience of the 2023 bull market. However, this outperformance raises the bar for the upcoming earnings report because tech companies are pressured to deliver results that could justify this latest hype.

But here is the catch, are investors anticipating strong numbers or solid guidance? As AI is a long-term growth driver, tech giants are more pressured to provide optimistic guidance rather than solid fundamentals. Hence, don’t be surprised if guidance is what moves the stock price after the earnings report even if the firm misses its estimates hard.

Growth drivers

On July 18, Microsoft announced its new AI subscription service, Copilot, which will cost an additional $30 a month for existing customers. As its name suggests, this new AI feature will support users in using the traditional products such as Word, Excel etc. More than anything, this move endorses the fact that Microsoft has been increasingly tilting its interest towards AI initiatives to capitalise on the recent AI mania.

Moreover, Microsoft is drawing closer to reaching an agreement for the acquisition of Activision Blizzard, which would strengthen the firm’s position in the video games market. Apart from gaining market share in a growing and innovative business segment, Microsoft will also diversify its revenue stream.

Last but not least, investors are likely to look out for any developments regarding ChatGPT in a time when more and more players are trying to launch similar tools. Microsoft has already started to integrate ChatGPT into its Bing search engine and it would be interesting if it manages to steal some market share from the almighty Google search engine.

Poised for solid fundamentals

Microsoft is set to post a strong second quarter financial performance despite the slowing economic activity globally, suggesting that its latest share price rally is not solely driven by growth expectations. The software giant is projected to report revenue of $55.45 billion, according to consensus estimates by Refinitiv IBES, which would represent a year-on-year growth of 6.92%.

Earnings per share (EPS) are estimated to jump to $2.55, producing an increase of 14.45% compared to the same quarter a year ago.

Asymmetric risks due to high valuation

From a valuation perspective, Microsoft appears to be trading at a premium compared to its major tech competitors, which could have two different interpretations. On the one hand, investors might be confident that the firm has an edge regarding the adoption of AI technology relative to its peers, but it could also mean that the share price is currently overvalued.

Specifically, its forward 12-month P/E ratio is currently at 32.8x, with all its major competitors and relative benchmarks retaining significantly lower figures. This aggressive pricing opens the door for significant downside in the case that Microsoft fails to live up to its expectations within the AI sector.

New all-time high in sight?

Microsoft’s share price has been in a strong rally since the beginning of the year, posting a new record high of $366.78 last Tuesday before paring some gains. Will a solid earnings report trigger another advance and propel the share price towards consecutive record highs?

To the upside, the recent all-time high of $366.78 could be the first barrier for the bulls to clear, if it is not already violated until the earnings announcement date. Even higher, the $400.00 psychological mark could be targeted.

Alternatively, should financial figures disappoint, the price could descend towards the previous resistance of $351.50, which could serve as support in the future. A violation of that zone could open the door for the July support of $327.00, which lies very close to the 50-day simple moving average (SMA).