Technology giant Microsoft (MSFT -1.27%) has become a Wall Street darling again thanks to its prominent position in the rapidly expanding artificial intelligence (AI) space. Its partnership with OpenAI, the company that developed ChatGPT, has brought Microsoft to the forefront of the ongoing AI revolution.
According to ARK Invest's Big Ideas 2023 report, AI is estimated to generate $90 trillion in enterprise value in 2030. Even if it only reaches a fraction of that estimate -- an older report by PWC, for example, places its estimate at roughly $16 trillion -- the potential in the space is undeniably massive. Microsoft's shares are now up by roughly 40% so far this year. Yet there is still significant upside potential in the stock, especially for long-term investors.
Here are three reasons why retail investors should add Microsoft stock to their portfolios now.
1. Growth opportunities in cloud gaming
On May 15, European Union regulators gave their approval to Microsoft's proposed $68.7 billion acquisition of major gaming company Activision Blizzard. That approval came just a few weeks after U.K. antitrust regulators came to the opposite conclusion, blocking the deal based on the premise that it would give Microsoft a monopoly position in the nascent cloud gaming space. In the U.S., the Federal Trade Commission has likewise filed suit to block the deal on anti-competitiveness concerns.
While securing approval in the U.S. and U.K. markets remains a challenge, the EU approval can be considered a major win for the company. Microsoft had to make several concessions to assuage the European Commission's concerns about the acquisition.
The deal, if completed, will add famous game franchises such as World of Warcraft, Call of Duty, Overwatch, Diablo, and Candy Crush to Microsoft's portfolio -- and bolster its cloud-based Xbox Game Pass service. This will enable Microsoft to capture a significant share of the cloud gaming market, which Grand View Research forecasts will expand at a compound annual rate of roughly 46% between 2022 and 2030, growing from $1 billion to nearly $21 billion over that time span.
2. Azure continues to grow its market share
In its fiscal 2023 third quarter, which ended March 31, Microsoft's Azure and other cloud services revenue grew 27% on a year-over-year basis, while Amazon Web Service's sales rose by 16%. AWS and Azure dominate the global cloud infrastructure market with shares of 32% and 23%, respectively. Although AWS is still the leader, it has lost 2 percentage points of market share since the third quarter of 2022. Azure, on the other hand, has gained 2 percentage points of market share.
Azure is also well-positioned to benefit from the huge growth in demand for data and computing resources required to power AI capabilities. Plus, organizations are also preferring Azure for its AI capabilities. At the time of its fiscal Q3 earnings call, the company reported that it had more than 2,500 customers for its Azure OpenAI service, up 10x on a sequential basis.
3. Artificial intelligence capabilities
Microsoft's investment in OpenAI (rumored to be close to $10 billion) has enabled the company to add generative artificial intelligence capabilities to its existing offerings.
The ChatGPT-integrated version of the Bing search engine is already capturing market share from Alphabet's Google in the internet search space. The company has integrated the most advanced GPT-4 language model into its Azure cloud computing platform, giving its clients access to advanced AI models they can use to develop their customized applications. Microsoft has also introduced Dynamics 365 Copilot, an interactive, GPT-4 powered assistant that can help automate tedious tasks across business lines such as sales, marketing, customer service, and supply chain management. And it's integrating advanced artificial intelligence capabilities into business segments such as GitHub, LinkedIn, and Teams.
Unlike early stage, pure-play AI companies built around nascent technologies, Microsoft boasts advanced and well-proven AI capabilities -- and it's capable of monetizing these technologies.
Conclusion: Microsoft stock is a buy
Microsoft is currently trading at a price-to-earnings ratio of 36, significantly more expensive than the tech-centric Nasdaq-100's price-to-earnings ratio of 20.
Although the company's valuation may seem high, several factors justify that premium. First, Microsoft is a stable company that can look forward to monetizing AI technologies. Second, it has a solid balance sheet with total cash and equivalents of $104.4 billion -- significantly more than its total debt of $79.3 billion. Third, management committed to returning value to shareholders, as is evident from the $9.7 billion it distributed via dividends and share repurchases last quarter.
Hence, considering the overall health of the company amid the ongoing AI frenzy, I believe this stock is a solid buy now.
