Microsoft (MSFT 2.09%) became a favorite on Wall Street this year, with its stock up 46% since Jan. 1. Investors grew bullish over the company's prospects in the artificial intelligence (AI) market, which is projected to expand at a compound annual rate of 37% through 2030. Meanwhile, Microsoft's position as the largest investor in ChatGPT developer OpenAI made it one of the biggest names in the lucrative industry.
However, before you dedicate a large portion of your portfolio to this tech giant, it's wise to be aware of the potential positives and negatives of its business.
The company could profit significantly from AI over the long term, but increasing competition may make navigating the untested market tricky. So, here's one green flag and one red flag for Microsoft in 2023.
Green flag: Betting on artificial intelligence
Microsoft got a significant head start in AI compared to competitors like Amazon and Alphabet. The launch of OpenAI's ChatGPT last November kicked off an AI race among most of the world's biggest tech giants.
Meanwhile, Microsoft's position as the biggest investor in OpenAI made it a leading name in the high-growth industry. The partnership granted Microsoft exclusive licenses on several of the start-up's AI models, allowing it to bring AI upgrades to many homegrown platforms.
While Microsoft's competitors have been busy playing catch-up, the Windows company has been one of the first to offer a library of generative AI services.
Earlier this year, the tech giant launched Copilot, a tool that automates specific elements of coding. And in February, Microsoft impressed by integrating OpenAI's language model into Bing through a chatbot called Sydney. Office productivity programs like Word and Excel have also received AI updates that make content creation more efficient.
The boom in AI motivated Microsoft to continue investing in the market, with Bloomberg reporting in May the company is bolstering Advanced Micro Devices' chip development. The company is supplying financial and engineering aid in the hopes of creating an alternative to the current leader, Nvidia.
Microsoft has gone all in on AI and could be one of the companies to profit most from the market's long-term development.
Red flag: Increasing competition
The massive potential of AI has unsurprisingly attracted many companies. The release of ChatGPT saw Alphabet launch its own version called Bard only a few months later.
Meanwhile, Amazon has heavily invested in expanding Amazon Web Services' (AWS) generative AI offerings. Even Apple is reportedly developing its own AI chatbot that engineers have nicknamed Apple GPT.
However, the biggest threat to Microsoft so far seems to be Amazon. Alphabet's smaller cloud business puts it significantly behind Microsoft, while Apple's AI expansion is primarily focused on upgrading its devices for the consumer market.
Amazon is home to the world's biggest cloud platform and potentially has the resources to match Microsoft's AI services soon. Rather than add another AI chatbot to the market, Amazon's strategy is focused on serving other generative AI needs.
In June, AWS unveiled two new platforms, including a language model-enabled service called Bedrock, which helps clients create custom chatbots and image generation services. The second is CodeWhisperer, a code-generating tool that makes software development more efficient.
Moreover, Amazon has become one of the first cloud companies to expand into the hardware side of the industry by developing its own chips. By fully controlling its AI hardware and software, Amazon could grow into a formidable opponent for Microsoft.
The good news is Microsoft's financials indicate it is a more reliable option for investing in AI than Amazon. The chart below shows how Microsoft's free cash flow is significantly higher than Amazon's, with recent macroeconomic challenges hitting the retail company far harder than Microsoft.
Data by YCharts
Additionally, Microsoft shares gained 224% since 2018, with Amazon's increasing by a more moderate 43%. With its massive head start in AI, Microsoft's financially healthier business could see its stock soar in the coming years as it profits from the industry's growth.
