Microsoft has been a juggernaut since going public in 1986, producing incredible wealth for its shareholders. While the last 10 years have been exceptional for the company, its new AI ventures may secure phenomenal returns over the next 10 years.
Microsoft MSFT has been one of the best performing large-cap stocks over the last decade, compounding at nearly 30% annually. It has tripled the returns of Alphabet GOOGL over that time, and just slightly underperformed Apple AAPL.
The AI hype kicked off earlier this year when MSFT subsidiary OpenAI released its ChatGPT product, a chatbot that has amazed even the most skeptical spectators. Then Microsoft released its AI enabled Bing search, which shook Alphabet investors considering its stranglehold on the search market. Finally, on Tuesday this week, Microsoft announced the newest addition to its AI line up, 365 Copilot, an AI enabled version of its widely used Microsoft Office 365 apps.
While investors are anticipating Microsoft’s earnings release on Tuesday, July 25, this new product may have just added a few hundred billion dollars of value to MSFT’s market cap, and completely shifted the focus of the report.
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AI Transformation Accelerates
Microsoft is really on a roll this year and seems to be outmaneuvering and even reinventing large segments of the tech industry and broader economy. The release of ChatGPT and then Bing AI was nothing short of earth shattering, but now with the most popular productivity software in the world being integrated with AI, MSFT may have just changed the game again.
Introducing Microsoft 365 Copilot may actually be the most significant business-related AI development of the year. Just a little quick math, 365 Copilot is going to cost $30 per month for premium enterprise users and Office 365 currently has ~355 million paid users. If say 100 million of those users convert to the new product it would add an additional $36 billion a year in revenue! And it would of course be a high margin product.
Copilot is apparently more than worth it as well. Many early users have already stated they are never going back. The use cases for the AI enabled software is quite exciting and should truly enhance users’ productivity.
It will offer instant document drafting in Word, data analysis in Excel, efficient inbox management in Outlook, and productive meetings with Teams. Copilot will also automate tasks in Power Platform, provide valuable insights through Business Chat, and adapt to users' needs. I look forward to trying it out.
Earnings Estimates
The earnings revision trend for Microsoft has been mixed, giving it a Zacks Rank #3 (Hold) rating. Earnings for the current quarter are projected to grow 14.4% YoY to $2.55, and sales are expected to climb 7% to $55.4 billion.
However, with this new development, those analysts’ models may no longer be relevant. It will be interesting to see what additional color management adds at the upcoming earnings announcement.
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Valuation
Microsoft is trading at a one year forward earnings multiple of 33.4x, which is above the market average of 21.4x and well above its five-year median of 30x. While that is an above average multiple for the tech behemoth, all these new developments, and huge potential for the future should boost its long-term top and bottom line. It is hard to imagine, but MSFT may become an even more dominant player meaning this premium valuation may not be premium for very long.
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Bottom Line
Microsoft is as good a stock as they come. With products across the spectrum of tech from video games, and social media, to hardware and software. Not to mention its cloud services, Microsoft Azure, growing at nearly 20% annually.
I should note I think that Azure growth has the potential to surprise to the upside at the coming announcement. While many analysts have noted the considerable slowdown in cloud sales at Microsoft, Google, and Amazon, the technology sector just went through one its most painful contractions since the early 2000s. With the economy regaining its footing, and the smaller tech players picking up again, it could mean a reacceleration of cloud sales growth.
Of course, nobody knows what the quarterly report will say, or how the market will react, but MSFT is without a doubt a fantastic long-term investment. From a tactical perspective, the stock has made a huge run up over the last couple months, and there is potential for earnings to be a sell the news event. In that case, it may present an opportunity to pick up shares after a sell-off.
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