One of the recurring headlines in 2023 has been the rebounding tech sector on Wall Street, fueled by the rapid adoption of artificial intelligence (AI). The debut of ChatGPT late last year illustrated the potential productivity gains made possible by large-language models and the resulting development of generative AI. While experts agree the potential is vast, there's no consensus on just how large the market for AI will ultimately be.
Cathie Wood's Ark Investment Management is among the technology's biggest bulls and estimates that AI could represent a $14 trillion opportunity by 2030. More-conservative predictions from Morgan Stanley and Goldman Sachs estimate the market opportunity at $6 trillion and $7 trillion, respectively, by the end of the decade.
Microsoft (MSFT -0.41%) and Alphabet (GOOGL 1.04%) (GOOG 1.06%) are both working to stake a claim for AI supremacy in the cloud, and while that battle is far from over, Microsoft has taken an early lead.
Image source: Getty Images.
A tale of two tech titans
Microsoft and Alphabet reported their quarterly results after the market close on Tuesday, and suffice it to say, Wall Street was keen to parse the results.
Expectations were high for Microsoft, and it didn't disappoint. For its fiscal 2024 first quarter (ended Sept. 30), revenue was $56.5 billion, up 13% year over year, while diluted earnings per share (EPS) of $2.99 climbed 27%.
To give those figures context, analysts' consensus estimates were calling for revenue of $51.4 billion and EPS of $2.50, so Microsoft exceeded expectations by a wide margin.
Investors also had high expectations for Alphabet, and the company delivered as well. For the third quarter, revenue was $76.7 billion, up 11% year over year, resulting in diluted EPS of $1.55. Analysts' consensus estimates were calling for revenue of $75.9 billion and EPS of $1.45, so Alphabet also sailed past expectations.
Given those results, you might expect both stocks would be rising. But in afternoon trading on Wednesday, Microsoft was the clear winner, gaining roughly 4%, while Alphabet stock skidded lower, down nearly 9%.
On the surface, it appears both Microsoft and Alphabet investors would have reason to celebrate, but a look under the hood shows that Microsoft pulled ahead on one very important metric.
Sunshine on a cloudy day
Alphabet investors had much to be happy about, but they instead focused on the results of its cloud infrastructure business, and did not like what they saw. Google Cloud generated revenue of $8.4 billion, up 22.5% year over year, its slowest growth in nearly three years. Wall Street had been anticipating cloud revenue of $8.6 billion.
Chief Financial Officer (CFO) Ruth Porat blamed "customer optimization efforts" for the tepid showing without providing any additional context.
Microsoft's Azure cloud results were in sharp contrast to its rival, increasing 29% year over year, reaccelerating after five consecutive quarters of slowing year-over-year growth. CFO Amy Hood, while acknowledging the optimization trends, said that Azure's revenue growth was fueled by "higher-than-expected AI consumption."
So, not only did Microsoft steal cloud market share from its rival, but it also did so on the back of its AI offerings. Market watchers chalked that up as an early AI win for Microsoft.
Early innings
To be clear, it's still the early innings in the AI revolution and far too soon to call a cloud winner. That said, there's plenty of reason to be optimistic for both Azure and Google Cloud, even though this first volley has gone in Microsoft's favor.
Needham analyst Laura Martin has predicted that the AI offerings of the three biggest cloud providers -- Microsoft, Alphabet, and Amazon -- could propel their market caps above $3 trillion, saying, "Generative AI will redefine the basis of competition for media and internet companies."
Microsoft and Alphabet's market caps sit at $2.5 trillion and $1.6 trillion, respectively, as of this writing, which suggests potential upside of 18% and 89%, according to Martin's rudimentary calculations.
Furthermore, given the trillions of dollars at stake, there will almost certainly be more than one winner in AI, and it's likely that Microsoft and Alphabet will both still be standing when the dust finally settles. That's why both stocks remain on my buy list.
