Conversational chatbot ChatGPT reached 1 million users in just five days following its launch last November, and it reached 100 million users in just two months, making it the fastest-growing consumer application in history, according to analysts at investment bank UBS. That explosive adoption hints at robust demand for generative artificial intelligence (AI) software in the years ahead.
Indeed, Morgan Stanley believes generative AI will unlock a $6 trillion market opportunity by improving online search, e-commerce, and digital advertising, among other uses.
Many companies are rushing to capitalize on that opportunity, but Microsoft (MSFT 1.82%) and Datadog (DDOG 4.95%) are particularly well positioned to benefit. Here's why.
1. Microsoft
Microsoft is the leader in enterprise software as a service, and Microsoft Azure makes it the second-largest cloud computing company. That should translate into strong revenue growth in the years ahead, since both markets are expected to increase at roughly 14% annually through 2030.
But Microsoft is leaning into artificial intelligence (AI) to supercharge growth in enterprise software and cloud computing, and the core of its strategy is an exclusive partnership with OpenAI.
Morgan Stanley analyst Keith Weiss says the perks of that partnership make Microsoft the software company best positioned to monetize generative AI.
For instance, Azure is the only cloud that offers access to OpenAI large language models, including the GPT models, allowing developers to build custom generative AI applications on the same foundation as ChatGPT. Azure is also the exclusive cloud provider for OpenAI, meaning Microsoft will benefit as the use of ChatGPT and other OpenAI products increases.
Microsoft itself has announced several products built on OpenAI models. Microsoft 365 Copilot will draft and edit content in Word, organize and analyze data in Excel, and create presentations in PowerPoint.
Dynamics 365 Copilot will provide sales insights, create marketing content, streamline customer service workflows, and improve supply chain management. And GitHub Copilot is already simplifying software projects for developers with auto-complete code suggestions.
Management says monetization of the Copilot products will ramp up slowly as they reach general availability in the coming quarters, but investors should see some impact by the second half of fiscal 2024 (ending June 30, 2024).
The slow onset notwithstanding, those products could be tremendous future revenue streams. According to Nvidia chief financial officer Colette Kress, AI-enabled assistants like Copilot will ultimately address a market opportunity worth many hundreds of billions of dollars.
Here's the bottom line: Microsoft's enterprise software and cloud computing revenue should grow in the low double digits through the end of the decade, maybe faster if its Azure offerings and Copilot products catch fire. That makes its current valuation of 11.6 times sales seem reasonable despite being a slight premium to the three-year average of 11.3. Investors should feel comfortable buying a small position in this AI stock today.
2. Datadog
Datadog helps businesses collect and make sense of observability and security data from across their IT environments. Its platform features more than a dozen products targeting different aspects of the corporate technology stack, but they collectively help clients keep their crucial applications and infrastructure performing.
Its software also leans on AI to accelerate incident remediation, and it does so to great effect. Forrester Research recently recognized Datadog as a leader in AI software for IT operations.
Datadog has innovated rapidly in recent years. It became the first platform to unify the three pillars of observability (i.e., metrics, traces, and logs) in 2018, providing clients with unmatched visibility across their applications and infrastructure, and the company has branched into new observability and cybersecurity verticals every year since.
Better yet, Datadog is a recognized market leader in several of those verticals, including application performance monitoring, log monitoring, and network monitoring.
Datadog earned $1.9 billion in revenue over the trailing 12 months, up 39% from the prior year, but management values its addressable market at $62 billion by 2026.
Given its track record, it should come as no surprise that Datadog recently announced two innovations meant to capitalize on the growing demand for generative AI. LLM Observability is a performance-monitoring product that helps businesses optimize their generative AI applications. And Bits is a generative AI assistant that helps development and operations (DevOps) teams investigate and remediate issues more quickly.
The bottom line: Datadog is a leader in several observability software verticals, and demand for its software should rise as technologies like generative AI make corporate IT environments more complex. In fact, Wolfe Research analyst Alex Zukin thinks interest in generative AI could make Datadog the fastest growing software company.
That means its current valuation of 16.2 time sales could look cheap in hindsight, and it's certainly a bargain compared to the three-year average of 35.6. Investors should feel comfortable buying a few shares of this growth stock today.
