Many artificial intelligence (AI) stocks have gone through the roof over the past few months, including high fliers like Nvidia or C3.ai. However, this trend has benefited other companies, including tech giant Microsoft (MSFT -0.39%).
The company has added nearly $1 trillion to its market cap since 2023 started, yet it doesn't have business results to back up the gains. As a result, I'm adding Microsoft to the list of companies that are seeing unreasonable hype thanks to AI. Read on to learn why investors should avoid adding to their Microsoft positions right now.
Chatbots aren't as much of a game-changer as people thought
Microsoft's products don't need much introduction; they are installed on nearly every computer globally and have significantly impacted how much computational power a business has with its cloud computing offering.
Although it's often forgotten, Microsoft also owns Bing, a search engine that has always trailed Google significantly. Once Microsoft beat Alphabet to the punch by integrating a chatbot into its search engine, many casual observers declared Bing the winner. This started the initial hype of the stock, although implementation of AI in other areas has added to the run-up.
Still, when did you last use the Bing chatbot after its release? I don't know many people who have integrated this feature into daily life, although it could change after a few years. If Bing can capture market share from Google, the stock will look more attractive. However, there is no evidence that that is happening.
Nevertheless, Microsoft's stock is up around 40% this year, unbelievable for a company as large as Microsoft.
However, the stock movement doesn't back up the results the business has been delivering.
The stock is expensive for its slow growth
Microsoft reported its third-quarter (ended March 31) results in April, leaving a lot to be desired. Revenue only rose 7% year over year, although earnings per share (EPS) were up 10% to $2.45. Its revenue guidance for the fourth quarter didn't help the company's prospects either.
| Segment | Revenue Guidance Midpoint | YOY Growth |
|---|---|---|
| Productivity and Business Processes | $18.05 Billion | 11% |
| Intelligent Cloud | $23.75 Billion | 16% |
| More Personal Computing | $13.55 Billion | (6%) |
| Total Revenue | $55.35 Billion | 7% |
Data source: Microsoft. YOY = year over year.
Revenue growth of 7% isn't going to translate into a stock that can significantly outperform the market. Yet, that's exactly what Microsoft's stock has been doing. Thanks to its recent outperformance, Microsoft's stock is now very expensive.
MSFT P/S Ratio data by YCharts.
With Microsoft approaching (and one valuation metric exceeding) the highs set at the end of 2021, right before tech stocks fell apart, it should be setting off warning signals in investors' heads. While Microsoft's stock will never look cheap, thanks to its strong execution over the past five years, 36 times earnings for a company that cannot grow faster than the market pace isn't sustainable.
While I'm not proclaiming Microsoft is an outright sell, I think it's wise for investors to avoid adding to any Microsoft positions now. Additionally, if Microsoft has been a massive winner in your portfolio, it may be time to take some gains off the table.
Once Microsoft begins growing at a 15% or greater pace, this valuation makes sense. Until then, Microsoft stock should be avoided until its price-to-earnings ratio falls into the mid-20s range -- a more historical average for Microsoft.
