The hype surrounding AI, thanks to OpenAI's ChatGPT, has likely been one of the main factors beyond Microsoft (MSFT -2.45%) stock's 33% gain this year. The company has jumped on the bandwagon in full force, making a handful of AI-related announcements this year, including the unveiling of new AI-based features for its search engine, internet browser, and productivity suite. Investors have cheered these moves, along with the company's better-than-expected fiscal third-quarter results and management's expectations for increased demand in an era in which AI helps fuel customer transformations.
Despite Microsoft's strong business performance and the strides it's making in AI, the stock's mouthwatering returns in 2023 should be scrutinized. Is Wall Street too optimistic? One analyst doesn't think so. Jefferies analyst Brent Thill just upped his 12-month price target for the stock from $350 to $400. He thinks the company is positioned exceptionally well for AI, thanks to its diverse and differentiated offerings that could benefit from it.
The path to $400
"Overall, we see the best-positioned groups to include hyperscalers, other enablers and data clouds, and large, differentiated platforms," said Thill in a note to analysts on Tuesday. In other words, he thinks differentiated and scaled tech companies like Microsoft and Alphabet (GOOG -1.96%) (GOOGL -1.97%) are well-positioned to benefit from the possibilities of artificial intelligence. With this in mind, the analyst boosted his price target on both stocks and reiterated buy ratings.
With price targets for Microsoft and Alphabet of $400 and $150, the implied upside of Thill's new targets for these stocks is 25% and 20%, respectively.
Microsoft said in its fiscal third-quarter earnings call that it believes it has "the most powerful AI infrastructure..." Supporting its case, it says its AI infrastructure is being used by OpenAI and NVIDIA (another tech company that has seen its stock soar amid the AI hype in 2023).
Strong cloud momentum
While the impact of AI will be broad-based across Microsoft's business, it's worth calling out a specific area of the tech company's business that is providing much of the infrastructure for the computing that goes into AI. Microsoft captures this revenue in its intelligent cloud segment, which includes revenue from its cloud-computing platform business Azure and other cloud services.
Fortunately, this is already a large and scaled business -- so investors don't have to wait for new AI-driven demand to really take off before investors can benefit from the segment's momentum. Intelligent cloud revenue in Microsoft's fiscal third quarter increased 16% year over year, easily outpacing the company's consolidated revenue growth rate of 7%.
Importantly, management expects this momentum to continue. The company guided for intelligent cloud revenue to increase 15% to 16% year over year in constant currency in fiscal Q4.
While investors should take analysts' price targets with a grain of salt and should do their own due diligence, Thill may be onto something. Not only is Microsoft already well-positioned to benefit from AI thanks to its positioning as an infrastructure provider but it also has some exciting new features coming out that will integrate AI across its offerings. More importantly, Microsoft stock's valuation, as shown by its price-to-earnings ratio of just under 35, is reasonable relative to the company's diversified and growing business.
