The day investors have been waiting for has finally arrived: On Feb. 29, the Nasdaq Composite hit a new all-time high. That, combined with gains of more than 20% from its bear-market bottom, checks the final criteria necessary to signal the onset of a bull market.
Despite those rather arbitrary benchmarks, there's reason for investors to be optimistic. Going back as far as 1926, bull markets have lasted 6.6 years, on average, generating gains of more than 339%, according to financial-services provider First Trust. A rising tide lifts all boats, or so the saying goes, so there's likely still plenty of gains to be had from the stock market's ongoing rally.
Furthermore, recent advances in artificial intelligence (AI) have created a groundswell of interest, and adoption is accelerating. One of the companies best positioned to tap into the zeitgeist is Microsoft (MSFT 1.82%). The company moved swiftly to get a leg up in the AI market and is already profiting from its early moves.
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Microsoft as my Copilot
It was arguably Microsoft's $13 billion investment in ChatGPT creator OpenAI that kicked off the generative AI-related frenzy that followed, but it was the introduction of Copilot -- the company's AI-powered digital assistant that should have investors most excited. Copilot is actually the generic name for a growing suite of AI-fueled helpers the company is adapting to a variety of use cases.
The most widely recognized is Copilot for Microsoft 365, which is deeply embedded in the company's Office Suite of productivity tools. Copilot helps automate many of the functions within Office, saving the user time and helping them become more productive. For example, Copilot can analyze data in Excel, create presentations in PowerPoint, and even make small work of emails in Outlook, all with just a few prompts from the user.
Microsoft has gone further, however, introducing a number of other Copilots for specific use cases. Over the past several months, the company has introduced Copilot for Sales, Copilot for Service, and Copilot for Finance, with each version bringing time savings and productivity enhancements to users -- and there are likely even more on the drawing board.
The evidence suggests Microsoft has a winner on its hands. A recent survey of Copilot users revealed that 77% reported that once they started using Copilot, they didn't want to stop.
The gem hidden in Microsoft's results
The opportunity represented by Microsoft's AI efforts is clear, but there's also a halo effect that investors might not fully appreciate. Besides the potential for the broad uptake of Copilot, there's another way for the company to capitalize on the growing adoption of AI, namely Azure Cloud.
Azure Cloud, the world's second-largest cloud-infrastructure provider, has been taking share from its rivals -- and that appears poised to continue. In the final quarter of calendar 2023, Azure's revenue grew 30% year over year, outpacing both Alphabet's Google Cloud and Amazon Web Services, which grew 26% and 13%, respectively.
In a gem hidden in Microsoft's earnings call, the company provided insight into what helped drive those gains, noting the results included "six points of growth from AI services."
This shows that as Copilot continues to gain ground, it will likely attract additional cloud users to Azure Cloud, further bolstering Microsoft's fortunes.
A significant catalyst
Estimates vary regarding how much Microsoft will ultimately profit from Copilot, but the forecasts continue to climb.
Analyst Sarah Hindlian-Bowler at Macquarie calculates that during its first full year of availability, Copilot could generate more than $14 billion in incremental annual-recurring revenue (ARR) -- and that's if just 10% of Microsoft's user base adopts its AI-fueled digital assistant. If a greater number of users adopt Copilot, the number could ultimately be conservative. Evercore ISI analyst Kirk Materne is much more bullish, suggesting generative AI could add more than $100 billion to Microsoft's results by 2027.
The significant gap between the two estimates suggests that this may not be an apples-to-apples comparison. It does, however, help illustrate the magnitude of the opportunity.
Microsoft has plenty of room to run
The evidence is clear that Microsoft is well positioned to benefit from the secular tailwinds of AI, yet despite that growth driver, it's remarkably affordable. The stock is currently selling for 34 times forward earnings, and while that's a slight premium to the price-to-earnings (P/E) ratio of 28 for the S&P 500, the company's recent advances suggest a premium is warranted.
There's more good news. During the two most recent bull markets, Microsoft has outperformed the broader indexes by a wide margin. For example, during the bull market that ran from March 2009 to February 2020, the Nasdaq Composite returned 674%, while Microsoft stock soared 1,140%. This helps to illustrate the company's strong track record during bull markets -- one more reason investors should buy Microsoft stock before the Nasdaq soars higher.
