Artificial intelligence (AI) promises to improve productivity in many different industries, potentially doubling the output of the average knowledge worker by the end of the decade. Meanwhile, the falling cost of training AI models is making the technology ever more accessible. The intersection of those trends could trigger a demand boom in the coming years.
Indeed, Cathie Wood's Ark Invest says AI software revenue will hit $14 trillion by 2030, up from $1 trillion in 2021, as enterprises chase efficiency. Many companies will undoubtedly benefit from the boom, but Microsoft (MSFT 1.82%) and Datadog (DDOG 4.95%) are particularly well positioned to capitalize on the growing demand for AI software.
Here's what investors should know about these AI growth stocks.
1. Microsoft
Microsoft announced solid financial results for the June quarter, topping consensus estimates on the top and bottom lines. Revenue rose 8% to $56.2 billion, driven by double-digit growth in enterprise software (e.g., Microsoft 365, Dynamics 365) and Azure cloud services, and generally accepted accounting principles (GAAP) earnings jumped 21% to $2.69 per diluted share as cost-cutting efforts paid off. But the company may be able to accelerate growth in future quarters.
The investment thesis is simple: Microsoft is the gold standard in enterprise software, and Microsoft Azure is the second-largest cloud services provider in the world. In both segments, the company aims to turbocharge growth by leaning into artificial intelligence (AI), and its exclusive partnership with ChatGPT creator OpenAI should be a significant tailwind. Indeed, Morgan Stanley analyst Keith Weiss says Microsoft is the software company "best positioned" to monetize generative AI.
In enterprise software, Microsoft accounted for 16.4% of global software-as-a-service (SaaS) revenue last year, earning nearly twice as much as its closest competitor, and industry experts have recognized its leadership in several quickly growing SaaS verticals, including office productivity, communications, cybersecurity, and enterprise resource planning (ERP) software. All four markets are expected to grow at a double-digit pace through 2030, according to Grand View Research.
In cloud computing, Microsoft Azure accounted for 23% of cloud infrastructure and platform services revenue in the first quarter of 2023, up from 21% one year ago, 19% two years ago, and 17% three years ago. Those consistent market share gains reflect strength in hybrid computing, AI supercomputing infrastructure, and AI developer services, according to CEO Satya Nadella, and they hint at strong growth in the coming years. The cloud computing market is expected to increase at 14.1% annually through 2030.
In AI software, Microsoft recently announced Microsoft 365 Copilot and Dynamics 365 Copilot, products that lean on generative AI to automate a variety of business processes and workflows. For instance, Microsoft 365 Copilot can draft emails in Outlook, analyze data in Excel, and create presentations in PowerPoint. Similarly, Azure OpenAI Services empowers developers to build cutting-edge generative AI software by connecting them with prebuilt AI models from OpenAI, including the GPT family of large language models.
Currently, shares trade at 11.9 times sales, a slight premium to the three-year average of 11.3 times sales, but a reasonable price to pay for a high-quality AI growth stock like Microsoft.
2. Datadog
Datadog has yet to release results for the June quarter, but the company turned in a solid financial report for the March quarter. Its customer count rose 29%, and the average customer spent over 30% more, despite a broader pullback in business IT investments. In turn, revenue climbed 33% to $482 million, and non-GAAP net income jumped 17% to $0.28 per diluted share.
Going forward, the investment thesis centers on digital transformation: Datadog provides observability and cybersecurity software that helps clients resolve performance issues and security threats across their applications, networks, and infrastructure. Demand for such products should snowball in the years ahead, as IT environments are made more complex by cloud migrations and other digital transformation projects.
Datadog has distinguished itself as a leader in several observability software categories, including application performance monitoring, network monitoring, log monitoring, and AI for IT operations. Industry experts attribute that success to its broad product portfolio, robust innovation pipeline, and data science capabilities. Indeed, Datadog brings together more than two dozen monitoring products on a single platform, and it leans on AI to automate tasks like anomaly detection, incident alerts, and root cause analysis.
Looking ahead, Datadog says its addressable market will reach $62 billion by 2026, and any trend that adds complexity to corporate IT environments should be a tailwind. For instance, Wolfe Research analyst Alex Zukin believes interest in generative AI could help Datadog become "the fastest-growing software company."
Currently, shares trade at 19.8 times sales, a bargain compared to the three-year average of 36.6 times sales. At that price, risk-tolerant investors should feel comfortable buying a few shares of this growth stock.
