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The rapid advancements in artificial intelligence (AI) have significantly impacted various industries, making AI stocks appealing to investors seeking growth opportunities. Among the many contenders in this space, tech giant Microsoft (MSFT) has emerged as a key player with its robust AI capabilities. The company had an impressive start to fiscal 2024, with outstanding growth across all its segments.
Last year, the stock soared 57%, outperforming the tech-heavy Nasdaq Composite ($NASX), which rose 44.5%.
Of course, Microsoft has run a very successful business even before the AI rush took over. Its financial stability and consistent revenue growth made it an appealing investment over the years, driving its stock to returns of 926% over the last 10 years.
Nonetheless, I believe there is much more AI potential to be unlocked, and the stock could reach its Street-high target price of $600 this year.
Diving Deep in the AI Game
Founded in 1975, Microsoft has blossomed into a global tech titan that provides software, hardware, cloud computing, and other services.
Microsoft's revenue has increased significantly over the last five years as a result of its diverse operations. Notably, revenue has climbed from $126 billion in fiscal 2019 to $212 billion in fiscal 2023, while earnings per share (EPS) have gone up from $5.06 to $9.68 during the same time.
Microsoft's cloud computing platform, Azure, provides an extensive set of AI services. Azure's scalable and flexible environment allows developers and businesses to seamlessly integrate AI solutions, ranging from machine learning to natural language processing. The widespread adoption of Azure by enterprises has solidified Microsoft's standing in the AI market.
Furthermore, with a 22% market share, Microsoft's Azure is ranked second in the cloud computing market, trailing only Amazon's (AMZN) AWS (Amazon Web Services).
The success of cloud is driving Microsoft’s growth, as seen in its most recent first quarter of fiscal 2024. Intelligent Cloud segment revenue came in at $24.3 billion, an increase of 19% year-over-year, accounting for the majority of Microsoft's total revenue of $56.5 billion, which grew 13% from the prior-year quarter. Operating income for the segment also surged 31% to $2.8 billion.
Notably, Azure revenue increased 29% year-on-year in the first quarter. CEO Satya Nadella highlighted that “more than 18,000 organizations now use Azure OpenAI Service.”
Microsoft has successfully incorporated AI capabilities into its existing product ecosystem, which includes Windows, Office 365, and Dynamics 365. All of its segments' revenue grew in the first quarter. Management anticipates Productivity and Business Processes segment revenue to be in the 11% to 12% range in Q2.
While the slow recovery in the personal computing market has been a drag on sales, management expects the Activision Blizzard acquisition deal (closed in October) to drive the segment’s revenue in the $16.5 to $16.9 billion range for Q2. This would represent a growth of 16% to 19% in the Personal Computing segment over the year-ago quarter.
The AI Growth Story Is Just Getting Started
The company's diverse revenue streams, which include cloud services and now AI-related products, help to strengthen its overall position in this competitive market.
Management believes Azure’s revenue will jump by 26% to 27% in constant currency terms, causing the Intelligent Segment revenue to fall in the $25.1 billion to $25.4 billion range in Q2.
For Q2 fiscal 2024, analysts expect Microsoft to report a 16% increase in revenue to $61.04 billion and a 19% increase in earnings to $2.76 per share. Furthermore, analysts predict revenue and earnings will increase by 14% and 15%, respectively, for the full fiscal year 2024.
Microsoft is set to release its Q2 earnings on Jan. 31, and we will learn more about Microsoft’s plan for fiscal 2024 then.
Microsoft trades at 34 times forward fiscal 2024 earnings, compared to its historical five-year average price-to-earnings ratio of 29. While it seems expensive, Microsoft’s long-term AI prospects might make it worth paying the premium.
What Does Wall Street Say About MSFT?
Recently, MarketWatch quoted Wedbush analyst Daniel Ives as saying, “The stock has yet to price in the next wave of cloud and AI expansion due to Microsoft’s strong competitive cloud edge.” Impressed with Microsoft’s AI products, Ives increased the target price on MSFT to $450 with a “strong buy” rating. Ives claims Copilot will bring in $25 billion in revenue for Microsoft by fiscal year 2025.
During the Q1 earnings call, the CEO noted that Microsoft now has 1 million paid Copilot users, and “over 37,000 organizations have subscribed to Copilot for Business.”
Microsoft faces stiff competition in areas such as cloud services, machine learning, and natural language processing, which could have an impact on market share and profitability. However, Ives is optimistic about Microsoft's competitive cloud advantage over other tech titans such as Amazon and Alphabet (GOOGL).
I, too, believe Microsoft has the potential to outperform Amazon and Google in cloud computing.
Wall Street is highly bullish about MSFT, giving it a “strong buy” rating overall. Out of the 37 analysts covering the stock, 31 rate it a “strong buy,” three analysts recommend a “moderate buy,” while three rate it a “hold.” The average target price for MSFT is $408.34, which is 5.1% above current levels. The high target price of $600 implies a 54% upside potential.
The Bottom Line
Microsoft has immense potential in the AI space, but its peers are also raising the stakes in the game. While I think Microsoft can eventually outperform Amazon in the cloud computing market, competition is fierce right now.
However, its robust AI platform, strategic acquisitions, integrated solutions, and legacy products position it favorably in the market. I am optimistic Microsoft will be able to achieve its high target price of $600 this year, making it my top AI stock pick for 2024.
On the date of publication, Sushree Mohanty did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
