Earnings season for the quarter that ended Dec. 31, 2022, is now underway, and Microsoft (MSFT -2.45%) was the first of the major technology companies to report.
Most Wall Street analysts have been predicting that high inflation and rising interest rates would begin showing up in the corporate sector's financial results at the end of 2022, and they were right. Microsoft's overall revenue growth slowed to a crawl, and its profits dipped compared to the same period in the prior year.
But macroeconomic factors like inflation tend to have a lag effect, and the U.S. Consumer Price Index appears to have peaked in July 2022. That means upcoming quarters could be much more positive for Microsoft. And given the fact that investors have sent the stock down on its latest quarterly result, that might spell opportunity for investors.
Microsoft stock has declined by 28% from its all-time high, but here's why the $1.8 trillion megacap is a buy on the dip.
The cloud picked up the slack
The biggest advantage Microsoft has in this tough economy is diversity. It collects revenue from both consumers and businesses, and often when one customer base spends less money, another picks up the slack. That phenomenon is occurring now.
Microsoft's consumer segments are suffering as people have less disposable income to spend on big-ticket items like new computers. The company's devices revenue and its Windows software revenue crashed 39% year over year in the fiscal 2023 second quarter. Likewise, its Xbox gaming brand saw a drop in both console sales and content revenue.
On the other hand, the cloud was the shining star once again. Azure is Microsoft's cloud services platform for businesses, offering it hundreds of services to help it operate in the digital world, including simple data storage, web hosting, virtual machines, and artificial intelligence (AI) tools.
Azure's revenue jumped 31% in the second quarter, making it the fastest-growing piece of Microsoft's business overall.
The net result for Microsoft was $52.7 billion in total revenue for the quarter, up just 2% compared to the year-ago period. But if not for the company's operational diversity, it could have been much worse.
The future is all about AI
Despite Microsoft's financial results being relatively muted in the quarter, the company was incredibly active in the AI space. It's still an emerging industry, and Microsoft is jostling for a leadership position, though it might already be there.
It has the most powerful cloud-based AI supercomputing infrastructure in the world to train and develop AI models, and it's used by customers like OpenAI, which built the ChatGPT conversational platform. Microsoft actually invested $1 billion in OpenAI back in 2019, but it just announced a follow-up multiyear deal worth up to $10 billion, which will allow for deeper integrations.
Microsoft Azure already offers OpenAI as a service, and it has being used by more than 200 corporate customers. Azure's growth in the AI segment is lightning-fast in general at the moment, especially in niche areas like machine learning (ML). Azure ML has now doubled its revenue in five consecutive quarters, and some of America's largest corporations are on its customer list.
But the partnership with OpenAI could revolutionize consumer assets like the Bing search engine, which has always struggled to gain ground on Alphabet's Google Search. Conversational tools like ChatGPT could completely change the way people seek information online.
According to an estimate by McKinsey, 70% of organizations will be using AI in some way by 2030, and the technology could add as much as $13 trillion to the global economy. Therefore, it's not surprising this is a core area of focus for Microsoft.
Microsoft stock can make a comeback
As I touched on earlier, Microsoft's profit sank in the second quarter. Its net income came in at $16.4 billion, which was down 12% year over year, leading to earnings per share of $2.20.
The stock has been on a downtrend for the past 12 months as investors expected slowing growth compared to 2020 and 2021, when the pandemic drove a rapid expansion of the digital economy. With the stock down 28% from its all-time high, it now trades at a price-to-earnings multiple of 26.7, which is a slight premium to the Nasdaq-100 tech index, but far cheaper than the highs of almost 40 seen over the last few years.
But there is a good chance Microsoft's earnings will reaccelerate alongside the recent decline in inflation since it should reignite consumer spending. Plus, the company just announced plans to lay off 10,000 employees in an effort to cut costs, and those savings should flow to the bottom line.
Over the long term, Microsoft stock has obliterated the performance of the broader market. With new opportunities emerging in industries like AI, the company could be set for a new phase of growth in the next decade and beyond, so investors might do well to buy the dip here.
