Understanding Microsoft's Backlog: What Does the Surge in Contracted Demand Really Mean for Investors?

Microsoft’s recent fiscal Q2 results revealed a striking figure that caught investors’ attention: the company’s commercial remaining performance obligations reached $625 billion. For many observers watching the tech giant navigate the AI boom, this number raises an important question—does a soaring backlog truly signal robust future growth, or is there more complexity beneath the surface?

What Backlog Actually Means: The Foundation for Understanding Microsoft’s Pipeline

Before diving into the numbers, it’s essential to clarify what this backlog represents. A backlog, in Microsoft’s context specifically referring to commercial remaining performance obligations (RPO), represents the dollar value of work that Microsoft has already contracted to deliver to customers, but hasn’t yet recognized as revenue. Think of it as a queue of committed work that will gradually convert into earnings over coming months and quarters.

This metric matters because it provides a forward-looking window into customer demand. The larger the backlog, the more contracted business Microsoft has sitting in its pipeline waiting to be fulfilled. In fiscal Q2, this backlog nearly doubled from the previous year, climbing 110% year-over-year. However, understanding what this really means requires looking beyond the headline number.

Examining the Growth: Where Did the Backlog Surge Come From?

The acceleration in Microsoft’s backlog growth was dramatic—the company’s commercial RPO increased 110% year-over-year in fiscal Q2, more than doubling the 51% growth rate recorded in fiscal Q1. This sharp acceleration reflects intense demand driven largely by enterprise spending on AI and cloud infrastructure.

Azure and other cloud services revenue did grow robustly, expanding 38% in constant currency during fiscal Q2. Yet here’s where things get interesting: this growth rate actually decelerated compared to the prior quarter’s 39% constant-currency growth. The backlog is accelerating while the actual revenue being recognized isn’t—a crucial distinction that investors often overlook.

Breaking down the composition reveals another important detail: a substantial concentration of this backlog comes from a single customer. OpenAI accounts for approximately 45% of Microsoft’s total commercial backlog. This customer concentration represents meaningful risk. Excluding OpenAI, the backlog growth drops dramatically to just 28% year-over-year, illustrating how dependent these figures are on one major relationship.

Four Reasons to Approach Microsoft’s Backlog with Caution

First, the timing question. Microsoft’s commercial RPO represents multiyear contracted work that will take considerable time converting into recognized revenue. While the total backlog surged, only 25% of it is expected to be recognized within the next 12 months. Even more telling, the portion expected to convert within the next year grew just 39% year-over-year—far slower than the 110% headline growth rate. This means investors could wait years for much of this backlog to materialize as actual profit.

Second, customer concentration creates vulnerability. Relying on one customer for 45% of your commercial backlog introduces significant business risk. Any disruption in that relationship, renegotiation of terms, or slowdown in that customer’s spending could substantially impact Microsoft’s near and medium-term revenue trajectory. The divergence between OpenAI-inclusive and OpenAI-exclusive growth rates underscores this dependency.

Third, converting backlog to revenue isn’t guaranteed to accelerate. Despite backlog growth accelerating, Azure revenue growth actually decelerated quarter-over-quarter. This pattern contradicts the bull case narrative—it shows that a growing backlog doesn’t automatically translate into faster revenue conversion. Microsoft may face constraints in delivery capacity, or the mix of business in the backlog may not convert as quickly as expected.

Fourth, capital spending is surging alongside backlog growth. Microsoft’s capital expenditures climbed to $37.5 billion in fiscal Q2, representing a 66% year-over-year increase. This massive spending spree reflects the company’s aggressive buildout of cloud and AI infrastructure. While management argues this spending will eventually unlock profitability from the backlog, investors should recognize the risk: if conversion takes longer than anticipated, or if economics disappoint, these elevated expenses could pressure margins in the interim.

What Microsoft’s Current Results Actually Tell Us

Rather than speculating about backlog conversion, investors might focus on what Microsoft is delivering today. In fiscal Q2, the company grew revenue 17% year-over-year with non-GAAP earnings per share expanding 24% year-over-year. For a company trading at approximately 27 times earnings, these results demonstrate solid operational momentum and reasonable valuation.

The valuation makes sense relative to current performance. However, the real debate revolves around whether Microsoft’s massive infrastructure spending will yield the profitability improvements management expects. That remains an open question with genuine uncertainty.

The Bottom Line for Stock Investors

Microsoft stock appears reasonably valued based on its present financial performance, not because of its backlog potential. The company is executing well today, and at roughly 27x earnings, that execution carries a fair price tag.

However, investors should view Microsoft as a higher-risk holding given the substantial capital expenditures, customer concentration in its backlog, and uncertainty surrounding how quickly that backlog converts into revenue at acceptable margins. The prudent approach suggests keeping any position in Microsoft measured rather than outsized, recognizing both the opportunities and the meaningful uncertainties ahead.