There will be a lot of also-rans in the artificial intelligence (AI) market, but investors don't need to take chances on risky start-ups. The large tech companies offer the safest way to invest in the growth of AI while still realizing market-beating returns.
Microsoft (MSFT 0.41%) and Google's parent company Alphabet (GOOG -1.74%) (GOOGL -1.51%) are great AI stocks to consider. These companies have billions in cash to invest in new technologies to drive demand for their services.
Microsoft share prices are up 40% year to date, while Alphabet stock jumped 35%. These companies have been investing in AI for several years and are in a good position to benefit from the growing demand for this technology, but their stocks are still fairly valued. Microsoft trades at a forward price-to-earnings (P/E) ratio of 35, while Alphabet shares trade at 22 times expected earnings.
As these two tech companies roll out new AI features across their businesses, they could see accelerating revenue and keep their stocks marching higher over the next decade. Here's how.
1. Microsoft
Analysts expect Microsoft to grow earnings by 12% per year over the next five years, which might not seem like enough growth to justify its P/E. However, considering the interest that the software leader is already seeing after introducing new AI features to some of its apps, I think it could surprise Wall Street over the next several years.
Microsoft is a partner with OpenAI, the creator of the generative-AI app ChatGPT, which can provide intelligent answers to simple questions. The app has reportedly reached 100 million users since last year's launch. The advantage for Microsoft is its brand recognition. When it announces new apps and technologies, it gets people's attention. When the company eventually launches generative-AI features in Word and Excel, it could substantially grow the 65 million users already using Microsoft 365.
While Office commercial products reported strong double-digit growth in the last quarter, the consumer offering posted just a 4% increase, excluding currency changes. The new AI features coming to Microsoft 365 could start a new wave of growth once inflation and economic headwinds are behind us. The acceleration in revenue from consumer productivity software is a catalyst for the stock.
Microsoft has already seen strong interest in downloads for its Bing search engine after introducing new AI features this year. Bing already has over 100 million daily users, but management said installs of the new Bing mobile app have grown fourfold since the updated version launched.
These are early indicators of how AI-powered software could see growing demand over the next decade and continue driving strong growth across Microsoft's core software business.
The stock is worth a premium due to Microsoft's large installed base of users, above-average growth, and recurring revenue from subscription-based services like Microsoft 365. Other AI stocks might outperform, but Microsoft is one of the safest options for investors.
2. Alphabet
AI could be an even bigger opportunity for the search leader Google and its parent company Alphabet. The technology is fundamental to Alphabet's business because it drives content recommendations on YouTube and search, which generate revenue from advertising.
AI has been the force behind Google's ad business for the past decade. It helps advertisers get more out of their campaigns with better returns on their investment. For example, Google uses AI to generate advertising headlines and descriptions that match user search queries.
Google is also preparing to roll out new generative AI search functions, which will make results smarter for users. Providing useful apps for billions of people is the heart of Alphabet's business, and it is the reason it's a leader in online advertising. It generated $54 billion in advertising revenue in the first quarter, out of nearly $70 billion in total revenue.
Alphabet's AI investments will also continue to fuel growth in Google Cloud, which has been its fastest-growing business, with revenue up 28% year over year in the first quarter.
YouTube has also been introducing new AI features to make it easier for content creators and businesses to make videos and run effective ad campaigns.
Overall, Google advertising, including YouTube ads, was virtually flat in the last quarter compared to last year. The uncertainty in the economy caused companies to tighten their budgets, but the advertising market will bounce back, and Alphabet should see strong growth as a result of AI tools.
If you're deciding between Microsoft and Alphabet, the latter might be the better value. Alphabet's forward P/E of 22 is a small discount to the average stock in the S&P 500 index, which might be undervaluing its future growth. For what it's worth, analysts expect the company's earnings to grow 17% per year over the next five years, which would be enough to potentially double the stock price.
