Microsoft Corp shares fell as much as 5 percent on Friday, a day after the software company reported a dip in its Windows operating system sales.

The world's second-largest tech company behind Apple Inc met Wall Street's profit estimate and beat on overall sales in its earnings report on Thursday.

But investors were concerned with lower personal computer sales nagging at Windows, Xbox sales bringing down profit margins and losses in its online business.

Microsoft shares closed down 3 percent at $25.92 on Nasdaq after a late-day rally. Earlier in the session they hit a low of $25.36, a 5 percent drop which would have been the largest one-day percentage fall since July 2009, had the shares closed at that level.

The shares ended around the level they were at on Monday, before a run-up leading into quarterly earnings. The stock had risen sharply after chip maker Intel Corp forecast revenue above Wall Street estimates, feeding optimism that a dip in PC sales last quarter did not indicate a long-term trend.

Everyone, including myself, pounded the table on the Intel trade, said BGC Partners analyst Colin Gillis. And it just didn't happen.

PC sales fell 1 percent last quarter, according to research firm Gartner [ID:nN13301394]. Microsoft's results reflected that, although it said business demand was outpacing weak consumer demand for PCs.

The stock is down 16 percent in the last 12 months, compared to a 16 percent gain in the Nasdaq.

There were two catalysts for the sharp decline in Microsoft, said Joe Cusick, senior market analyst at Chicago-based online brokerage firm optionsXpress. One, the stock broke through the 200-day moving average of $26.08, and UBS lowered their price target for the stock.

UBS analyst Brent Thill on Friday cut his price target on Microsoft to $32 from $35, citing the long-term threat posed by tablets to the traditional PC business.

Even though they had good earnings, the PC market is under scrutiny and there continues to be uncertainty on whether or not Microsoft can compete with the growing tablet and handheld devices from the likes of Samsung and Motorola, said Cusick.

Options traders, many of whom placed bets on Microsoft shares jumping earlier in the week -- perhaps as a hedge to holding the stock in case of a decline -- moved into a more critical mode.

There is nothing too rosy in Microsoft options trading on Friday compared to some of the bullish trades we saw ahead of earnings, said Caitlin Duffy, equity options analyst at Interactive Brokers Group in Greenwich, Connecticut.

For the most part, we are seeing call selling in near-term options, she said, indicating traders are looking to get rid of their rights to buy the stock.

Overall, Microsoft analysts kept their faith that Microsoft will survive a rough patch in PC sales. Twenty-five of 35 analysts polled by StarMine recommend buying the stock. Only one says sell.

As a result of Microsoft's decline, it is close to being eclipsed by old foe IBM in terms of market value. Apple, which overtook Microsoft last year, is the most valuable U.S. tech company at $321 billion, Microsoft is second at $225 billion and IBM is third at $207 billion.

(Reporting by Bill Rigby and Doris Frankel. Editing by Robert MacMillan, Bernard Orr)

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