Microsoft (NASDAQ:MSFT) is in the middle of a massive transition right now, but you may not have noticed. That's because the company is moving effortlessly into the burgeoning artificial intelligence (AI) market -- and it's bringing its legacy products and services along with it.
Over the past few years, Microsoft has successfully been building new features into its Office products and launching new AI-powered tools through its Azure cloud-computing service as the company looks beyond its Windows products to the fast-growing AI market.
Microsoft CEO Satya Nadella said recently that AI is the "defining technology of our times," and he's probably right. AI has the capability to alter how we drive our cars, it will help automate our factories, it will both create and kill jobs, it can be used in warfare, and it's already being used to help improve our healthcare.
AI's vast influence over nearly every aspect of our society also means it has massive benefits for companies that develop new features using the tech. Gartner estimates that $3.9 trillion in AI-derived business value will be created by 2022.
Perhaps that's why Microsoft has set its sights on AI and is driving full-steam ahead. The company set up its Artificial Intelligence and Research Group back in 2016 and staffed it with 5,000 computer scientists and engineers. The group's plan was to help the company develop AI in four main categories, including the company's Cortana digital assistant, its applications like Office 365, its services, and Azure cloud-computing infrastructure.
Now, the company has more than 8,000 people working in its AI research division, and Microsoft has a host of new AI services and features that prove the company's commitment to AI is more than just puffery. The most recent shift came this year, when Nadella announced a restructuring of the company so it can give AI even more of a focus.
If you're tempted to think of Microsoft as merely the Windows and Outlook maker, or the tech company that infamously could never figure out the smartphone market, then it's time to take a closer look at how this tech stalwart is morphing into an AI-first company.
What exactly is artificial intelligence?
To fully grasp how Microsoft will benefit from its increasing shift toward AI, it's important first to understand what artificial intelligence is.
Many times, the term AI conjures up images of robots walking around doing our bidding (or trying to take over the world). But while that general idea of AI is popular, what most companies are working on is what's called "narrow AI."
Narrow AI, according to the graphics processor maker NVIDIA Corporation (NASDAQ:NVDA), is when a computer system can perform a task as well, or even better than humans can.
One of the best examples of this is Facebook's (NASDAQ: FB) image-tagging feature. Facebook is using a type of narrow AI that, when you upload a photo to Facebook, suggests a friend you should tag in the picture. Not only is the AI performing the task for humans, but it's doing it better than humans -- with 98% accuracy, and it's completing it much faster than a human can.
Microsoft's Azure cloud-computing service has similar capabilities for image classification, and the company has even created a site where you can upload your own images to its database. The website shows you how Azure's computer vision looks at a picture and labels what it's seeing, what colors are in the photo, what people are doing in the image, and can identify what the text in the photo says.
That's just one example of how AI works, but it certainly isn't where its intelligence ends. The next important aspect of AI you need to understand is what's called machine learning. Again, let's take a look at what NVIDIA -- which is an AI leader in its own right -- has to say about machine learning:
Machine Learning at its most basic is the practice of using algorithms to parse data, learn from it, and then make a determination or prediction about something in the world. So rather than hand-coding software routines with a specific set of instructions to accomplish a particular task, the machine is "trained" using large amounts of data and algorithms that give it the ability to learn how to perform the task.
A great example of machine learning is how automakers and technology companies are using their vast amount of visual data collected from self-driving cars to help the vehicles become smarter and improve their driving. Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) self-driving vehicle company, Waymo, uses machine learning to teach its vehicle's cameras to filter out snow on the road and other objects so the vehicle can continue to see, even in very poor weather conditions.
Driverless cars have their own computer vision, which is created using a combination of cameras, sensors, and software to see the world around them. Without machine learning, Waymo's vehicles would view the snow as a physical object in its way and would simply stay put.
How Microsoft is using AI in its Office products
Microsoft's Office products -- Word, Powerpoint, and Excel, for example -- have undergone some massive transitions over the past few years, most notably the shift to its subscription-based Office 365 model. But the company has also regularly updated its core software offerings to make them more intelligent.
For example, Office 365 subscribers can use what Microsoft called "ink analysis" to convert handwritten words in PowerPoint into text and allow users to draw their own shapes and have them transformed into objects. The service also allows users to sketch out an entire slide with text boxes and drawings and then convert it into a professional-looking slide using AI.
The company's AI also allows Office 365 subscribers to edit their Word documents with handwritten text, just like they would if they were marking up a physical page with edits. Users can insert words into sentences, make page and line breaks, and join separated words with pen-based gestures.
Microsoft introduced a slew of new AI services for Office 365 at the end of 2017, including Acronyms for Word and Time to Go for Outlook. The AI-based Acronyms feature helps Word users understand the shorthand created by companies by searching previous definitions found in emails and other documents and applying it the document you're currently working on.
The Windows maker has used its AI virtual assistant, Cortana, to make its Outlook email app far more useful as well. Microsoft believes Cortana is one of the biggest keys to AI's progression.
Last year, Nadella said:
[T]he agent knows you, your work context, and knows the work. And that's how we are building Cortana. We are giving it a really natural language understanding.
Cortana is used in myriad ways on Windows devices and in Microsoft's apps, including its Outlook email program. Cortana can automatically detect trips, meetings, and deliveries through a feature called Time to Leave. The digital personal assistant sifts through emails and then sends users a notification that it's time to leave for an appointment, and it can even factor in traffic data when it tells you when you go -- to help ensure you get there on time.
That might seem like a small feature, but it's part of a comprehensive list of artificial intelligence features that Microsoft is implementing to take its software to the next level. Microsoft says its "AI is already enhancing the productivity experience of over 120 million commercial Office 365 users," and the company's sales from Office 365 prove that the features are paying off.
In the third quarter of fiscal 2018, Microsoft's sales from its Office commercial productions and cloud services increased by 14% year over year. The company said revenues in this category were driven by Office 365 commercial revenue growth of 42%.
While it's clear that Microsoft is using AI to transform one of its legacy products and boost sales at the same time, the company's use of AI -- and its monetary benefits -- go way beyond its Office suite.
How Microsoft is using AI in its cloud-computing products
One of Microsoft's brightest spots over the past few years has been its growing cloud-computing business. The company recently reached a significant milestone of generating an annualized run rate for its cloud-computing business -- primarily fueled by its Azure services -- to $20.4 billion.
Microsoft offers a laundry list of what it calls Cognitive Services within its Azure cloud that help developers create new AI apps. Those services include image processing, data analysis, speech and language processing, and enhanced search capabilities. Microsoft says it's already had more than 1 million developers try its cognitive services.
The company has also been building out its Azure Machine Learning Studio, which allows researchers to take their data and easily apply machine-learning services to pull out relevant insights quickly.
Microsoft's AI services all fall under the umbrella of the company's Azure AI platform, which includes its toolkit full of cognitive services, its machine-learning studio, as well as the company's AI infrastructure for large-scale data processing using high-powered graphics processors.
Integrating all of these AI-powered capabilities into the company's cloud-computing service has helped Microsoft become one of the premier public computing companies in the world. Microsoft's Azure currently holds about 20% of the public cloud market and recently stole some market share away from the cloud leader, Amazon's (NASDAQ:AMZN) AWS.
In the most recent quarter, Microsoft's Azure revenue skyrocketed by 93% and helped drive the company's sales in its Intelligent Cloud revenue segment -- which includes Azure and other enterprise services -- by 17%.
Microsoft views AI as an integral part of its cloud-computing business because it knows its competitors are pushing hard into this space as well. Amazon has emphasized the importance of machine learning across all of its services and cloud computing, and Alphabet's Google's advancements in AI have caused Microsoft to team up with Amazon in the past to ensure that it stays ahead of Google's cloud-based AI services.
Research firm Gartner estimates that by 2021, the public cloud market -- which includes Azure and Amazon's AWS -- will be worth $302 billion, up from $186 billion in 2018. This market opportunity is why Microsoft's focus on building out its AI services within its cloud is so important.
No one understands how essential this is better than Nadella, who wrote in a post released during Microsoft's Build conference that:
[W]e're driving new advances in our underlying cloud infrastructure so that developers can build next-generation AI applications on our cloud. We're building the world's first AI super computer in Azure.
Microsoft has its eye on AI-powered healthcare as well
Last year, Microsoft launched its Healthcare NexT initiative, with the goal of bringing more cloud computing and artificial intelligence to the healthcare industry.
While it may seem like an odd use of AI, investors should consider that the U.S. spends about 18% of its gross domestic product (GDP) on healthcare-related expenses, according to research by the Kaiser Family Foundation. It's a far higher percentage than other developed nations spend on their healthcare, and Microsoft believes it can use AI to both improve healthcare and make it more efficient as well.
One of the most significant moves the company has made in the healthcare space has been the release of its Microsoft Genomics service, which researchers and hospitals can access through Azure. Artificial intelligence is used to sift through the vast amounts of genomic data that humans could never categorize alone. Microsoft noted in a recent blog post:
The more genomic data researchers can access and analyze, the more precisely they can tease apart the complexity of biology and make progress toward curing diseases such as cancer
The company has already partnered with St. Jude Children's Research Hospital to provide cloud-powered genomic processing services to help the hospital's researchers analyze and eventually help treat genetic diseases.
Microsoft is also looking to make healthcare more efficient for both patients and healthcare providers. The company has a partnership with the University of Pittsburgh Medical Center to help streamline the hospital's patient care. Microsoft's AI virtual assistants help physicians take notes when they're speaking with patients and then sends a summary of their conversation to the patient's medical file.
We're still at the very beginning stages of using AI to improve healthcare, but Microsoft has its eye on the growing need for healthcare efficiencies. Recent research by Accenture said that workflow assistants like the one mentioned above could eventually decrease work time for nurses by 51% and 17% for doctors. Additionally, the increased efficiencies could generate $150 billion in annual healthcare savings in the U.S. by 2026.
Microsoft is an AI powerhouse that's still growing
I've talked a lot about what Microsoft is doing in the artificial intelligence space, but investors should know that this company isn't anywhere near done building out its AI services.
It was only a few years ago when Nadella began positioning the company toward the cloud-computing market, and now that it has a leadership position in that market, it's turning its attention to how it can hold on to its dominance through AI.
If there's one thing potential Microsoft investors should know, it's that the company's AI pursuits are only likely to grow in the coming years. Cloud computing, personal computing, and mobile devices will increasingly morph into devices and services that are powered by artificial intelligence.
Accenture CTO Paul Daugherty recently described AI as the "alpha trend: the trend driving other trends and shaping what's happening with other technologies."
Microsoft is already helping to lead a transition to AI with Azure, Office 365, it's healthcare initiatives, and its Cortana virtual assistant, and we're likely to see the company dig even deeper in the coming years.
The great thing for investors is that even though Microsoft is building itself into a dominant AI player, the company's shares are still on par with the broader technology industry and trade at around 24 times the company's forward earnings. That's a fair price when you consider that the company's share price has already spiked about 40% over the past year and pays a respectable dividend yield of 1.72%. Factor into the equation that Microsoft is already benefiting from its AI pursuits and will see more growth from it in the coming years, and you have a recipe for a great long-term AI play.