One of the clear winners of the advent of artificial intelligence (AI) has been Microsoft (MSFT -1.00%). The stock generated impressive gains of 57% in 2023, tacking on an additional 12% so far this year (as of market close on Wednesday), and regularly breaches new all-time highs.
The company is best known for its ubiquitous Windows operating system, Office suite of productivity software, and Teams workplace collaboration platform. Most recently, however, Microsoft planted its flag in the area of generative AI, quickly integrating AI functionality into its roster of products and services.
This has investors in a quandary. After notching 75% gains in roughly 15 months, is Microsoft stock still a buy? Let's see what the data says.
Image source: Getty Images.
How Microsoft caught the competition flatfooted
It's easy to suggest that Microsoft was simply in the right place at the right time, but that would ignore the hard work going on behind the scenes. While generative AI first captured the spotlight early last year, Microsoft bet on the technology much earlier, investing $1 billion in AI start-up OpenAI back in 2019. Thus began a long-term partnership that helped take the technology to the next level.
The collaboration yielded a system that used supercomputers to train the large language models (LLMs) that underpin generative AI. The resulting bots could complete a variety of impressive tasks: generate frighteningly accurate images based on voice prompts, answer complicated questions, and complete the coding on an unfinished software app.
Microsoft decided to test the utility of this last bot within GitHub, a company it acquired in 2018. The platform, a place where developers worked together on software apps and shared code, was the perfect testing ground for such a tool. Despite its imperfections, developers flocked to the GitHub Copilot after its release in late 2021.
This success acted as a springboard for other Copilots that followed. In late 2022, Microsoft used a similar blueprint to train new versions of Copilot for each application in its Office Suite of workplace productivity tools. When Microsoft released a preview for public testing, Copilot contained "guardrails" or rules to limit incorrect responses. Furthermore, when Copilot responded to a query, it provided two responses, and testing partners were asked to choose the preferred response, further honing the tool's capabilities.
The results were so successful that Microsoft increased its stake in OpenAI to $13 billion by early 2023, accelerating the AI revolution that started with OpenAI's ChatGPT release.
Microsoft has since released a suite of industry- and job-specific Copilots, including those designed specifically for users in sales, service, and finance roles, with more on the drawing board.
CEO Satya Nadella has reported getting rave reviews from Copilot users. "Customers tell us that once they use Copilot, they can't imagine work without it."
Ringing the cash register on AI
It's too early to tell just how much this foray into AI will be worth to Microsoft, but that hasn't stopped Wall Street's best and brightest from trying. The company charges users $30 per person per month for Copilot for Microsoft 365. Analysts from Piper Sandler estimate this could generate incremental revenue of $10 billion by 2026. Macquarie Research suggests that Copilot could generate $14 billion in revenue in its first full year alone -- and that's if just 10% of Microsoft's enterprise customers use the product. Analysts at Evercore are much more bullish, calculating that Copilot could add as much as $100 billion in incremental revenue by 2027.
Microsoft stock is currently selling for roughly 36 times forward earnings, which is a premium compared to a multiple of 28 for the S&P 500 index. While no one knows for sure just how much the company will reap from its Copilot strategy, the bump in revenue will likely be substantial.
Be that as it may, the evidence suggests that Microsoft stock is still a reasonable buy, even near its all-time high.
