Generative artificial intelligence (AI) allows users to create content like complex images and sophisticated text from simple prompts written in natural language. The implications of the technology are enormous. Indeed, Goldman Sachs says two-thirds of U.S. occupations could be partially automated by generative AI in the coming decade, and doing so could add $7 trillion to the global economy.
Many companies will benefit from that rising tide, but Morgan Stanley analyst Keith Weiss is particularly bullish on Microsoft (MSFT -1.29%). Weiss wrote the following in a recent note to clients: "Generative AI looks to significantly expand the scope of business processes able to be automated by software, and Microsoft stands best positioned in software to monetize that expansion."
Here's why this AI growth stock is worth buying.
Microsoft delivered a solid fourth-quarter report
Microsoft reported solid financial results in the fiscal fourth quarter (ended June 30), topping Wall Street's projections on the top and bottom lines. As shown below, total revenue rose 8.3% to $56.2 billion, fueled by double-digit sales growth in the productivity and business processes and intelligent cloud segments, and net income under generally accepted accounting principles (GAAP) climbed 20% to $20.1 billion as cost management efforts continued to pay off.
Data source: Microsoft. Chart by The Motley Fool.
Shares of Microsoft still slid 4% after hours because revenue guidance for the current quarter implies 8% growth at the midpoint, but Wall Street had penciled in 10% revenue growth. The biggest miss came from the more personal computing segment, which contains the Windows operating system, where CFO Amy Hood says revenue could decline as much as 6% due to ongoing weakness in the PC demand environment. Wall Street was expecting more personal computing revenue to be flat.
Patient investors can put a positive spin on the situation, though. Weiss said Microsoft's valuation appeared reasonable in early July, when the stock traded at 12.3 times sales, but shares are now even cheaper after the post-earnings pullback. The analyst also has a 12-month price target of $415 per share on Microsoft stock, which implies 23% upside from its current price.
The investment thesis for Microsoft
Microsoft is the DNA of many modern organizations. The company raked in 16.4% of global software-as-a-service revenue last year, meaning it captured nearly twice as much market share as the next closest competitor. Of course, Microsoft is best known for its office productivity suite, Microsoft 365, which happens to be the most popular enterprise application product of any kind. But the company also has a strong presence in other verticals, including unified communications, cybersecurity, and enterprise resource planning (ERP) software. Those markets are expected to grow at 17.9% annually, 12.3% annually, and 11% annually through 2030, according to Grand View Research.
Microsoft is also gaining market share in cloud computing. Azure accounted for 23% of cloud infrastructure and platform services (CIPS) in the first quarter of the calendar year, up from 21% one year ago and 19% two years ago. CEO Satya Nadella says that momentum reflects strength in hybrid computing solutions, artificial intelligence (AI) supercomputing infrastructure, and AI developer services. That momentum also positions Microsoft for strong growth in the future, as the cloud computing market is expected to increase at 14.1% annually through 2030.
So what? Microsoft has a strong presence in several markets projected to grow at a double-digit pace through the end of the decade, meaning the company already has a great shot at delivering double-digit revenue growth during the same period. But Microsoft is leaning aggressively into AI software -- a market that Ark Invest says could swell at 42% annually to reach $14 trillion by 2030 -- and that could turbocharge its top-line growth in the coming years.
Microsoft is well positioned to monetize demand for generative AI
Microsoft has invested more than $10 billion in OpenAI, and Weiss says that investment will evolve into a $90 billion market opportunity by 2025 as Microsoft embeds generative AI capabilities across its enterprise software products.
Indeed, the company recently announced Microsoft 365 Copilot, a product that leans on generative AI to write content in Word, analyze data in Excel, and create presentations in PowerPoint. Microsoft plans to charge a monthly fee of $30 per user, more than double what it charges for the least expensive version of Microsoft 365.
Microsoft has also announced Dynamics 365 Copilot, a product that leans on generative AI to streamline ERP workflows. For instance, Dynamics 365 Copilot can boost sales team productivity by drafting emails and summarizing meetings, it can improve service team efficiency by handling customer queries without human intervention, and it can improve supply chain management by predicting issues that may arise due to external circumstances.
Additionally, Microsoft Azure OpenAI Service is a cloud computing product that offers exclusive access to large language models from OpenAI, including the GPT models behind ChatGPT. Those technologies empower developers to build state-of-the-art generative AI applications, and organizations are eager to join. Management said Azure OpenAI Service now has over 11,000 customers, up from 4,500 in May.
Here's the bottom line: Microsoft already has a strong market presence in enterprise software and cloud computing, and its AI-centric product development strategy promises to turbocharge demand in both segments. With that in mind, its current valuation of 11.8 times sales appears reasonable. That's why investors should buy a small position in this growth stock today.
