Microsoft (MSFT 0.22%) hit a new all-time high on Tuesday in lockstep with a broader market rally. A few days earlier, during an event at the new Microsoft campus on May 20, the tech giant introduced a lineup of Windows personal computers (PCs) designed for artificial intelligence (AI).
Dubbed Copilot + PC, the product offering includes Microsoft Surface and manufacturing partners Acer, ASUS, Dell Technologies, HP, Lenovo, and Samsung with prices starting at $999 and availability as early as June 18.
Here's what Copilot + PC adds to Microsoft's already strong investment thesis and why the growth stock has what it takes to hit a $10 trillion market cap by 2035.
Image source: Getty Images.
The next step for everyday AI
On its third-quarter fiscal 2024 earnings call, Microsoft said that Copilot in Windows is now available on nearly 225 million Windows 10 and Windows 11 PCs -- double the amount of the prior quarter. Copilot is Microsoft's AI-powered chatbot assistant for Microsoft 365 apps and more. According to the May 20 press release:
Copilot+ PCs are the fastest, most intelligent Windows PCs ever built. With powerful new silicon capable of an incredible 40+ TOPS (trillion operations per second), all-day battery life and access to the most advanced AI models, Copilot+ PCs will enable you to do things you can't on any other PC. Easily find and remember what you have seen in your PC with Recall, generate and refine AI images in near real-time directly on the device using Cocreator, and bridge language barriers with Live Captions, translating audio from 40+ languages into English.
Building PCs with AI in mind is a boon for the industry because it supports the demand for AI-powered chips, can increase users' productivity, and creates opportunities for developers and consumer electronics companies. In its recent earnings call, Microsoft said it offers a diverse set of AI accelerators made by Nvidia, Advanced Micro Devices, and its own "first-party silicon."
A big test for the AI growth narrative is adoption. If consumers embrace these latest AI-focused products, it will validate that AI is not a fad but the next information revolution.
The ultimate AI play
Microsoft may not be the purest AI play out there (Nvidia would take the title in my opinion). However, Microsoft is arguably the most multilayered AI opportunity because it is monetizing new technology in so many ways.
In addition to the PC market, Microsoft has integrated AI into its Intelligent Cloud business through Azure OpenAI, which is used by over 65% of Fortune 500 companies.
GitHub Copilot continues to grow at a blistering rate. Two quarters ago, in Q2 of fiscal 2024, Microsoft reported a 30% quarter-over-quarter increase in subscribers, bringing the total number of paid subscribers to 1.3 million. Yet somehow, it posted even faster growth in Q3, growing paid subscribers to 1.8 million -- a 35% increase.
Microsoft also offers custom AI assistance with Copilot Studio. It reported a 175% quarter-over-quarter increase in Copilot Studio adoption, bringing the total number of organizations that use the service to over 30,000. Power Platform is a similar tool for businesses to build AI-powered applications. In the recent quarter, Microsoft said that over 330,000 organizations, including over half of Fortune 100 companies, use Power Platform. Power Apps, which uses Copilot to help users write code for app designs, grew over 40% year-over-year to over 25 million monthly active users.
The key takeaway from the last few earnings calls is that Microsoft is rapidly monetizing AI across its business. This isn't a pie-in-the-sky idea; it's developing, implementing, and marketing solutions right now.
The power of deep pockets
Spanning cloud computing, enterprise and consumer software and hardware, gaming, social media, and more, Microsoft has a wide array of touchpoints to engage with a variety of customers. In addition to its industry-leading position in so many end markets, the company's greatest advantage is its margin of error.
AI and the tech sector, in general, will eventually undergo a cyclical downturn. When that happens, the companies with the cash flow and balance sheets to invest through the cycle will emerge stronger. No company is better positioned to endure and probably benefit from a downturn than Microsoft.
It finished the recent quarter with just over $80 billion in cash, cash equivalents, and short-term investments on the balance sheet, compared to $42.7 billion in long-term debt.
Its revenue, net income, and operating margin are all at 10-year highs. It has generated $86.2 billion in trailing-12-month (TTM) net income, which is more than double the $21.3 billion it has spent on dividends and the $16.8 billion spent on buybacks. The company has the means to invest aggressively in organic growth, make strategic acquisitions, raise the dividend, and buy back its stock.
Microsoft pays more in dividends than any other U.S.-based company and is spending more on buybacks than it pays in stock-based compensation. It is now reducing its outstanding share count, reversing a dilution trend due to stock-based compensation. Microsoft is at the top of its game. But it also has what it takes to endure a downturn while rewarding shareholders through buybacks and dividends and investing in its long-term growth.
The path to $10 trillion
In August 2018, Apple became the first U.S.-based company to exceed $1 trillion in market cap -- a feat that once seemed impossible. However, Nvidia has gained over $1 trillion in market cap this year alone.
With a $3.2 trillion market cap, Microsoft is currently the most valuable company in the world. The stock is up over 1,100% in the last 11 years. Thanks to the power of compound growth, it doesn't need anything close to that gain to reach a $10 trillion market cap by 2035.
Microsoft's market cap only needs to grow at a 10.9% compound annual growth rate over the next 11 years to reach a $10 trillion market cap. There are a few ways that could happen.
The first and most straightforward is earnings growth. If Microsoft maintains the same price-to-earnings (P/E) ratio, the stock price would hypothetically increase at the same rate as earnings.
Microsoft's current P/E is 37.2. If it grows earnings by 10%, the stock will have to go up by 10%, or the P/E would drop. Now, I'd argue that Microsoft will be able to grow earnings per share (EPS) at more like a 15% CAGR over the next 11 years, especially when factoring in buybacks. However, I could also see the valuation coming down if growth and investor optimism begin to cool.
Assuming a P/E of 30 and a 15% earnings CAGR over the next 11 years, Microsoft would grow EPS from $11.54 to $54. Apply a 30 P/E on that figure, and the stock price would be $1,620 -- giving Microsoft a market cap of just over $12 trillion.
So, even if Microsoft's P/E comes down, it could still get to $10 trillion by 2035 if it grows annual EPS at a low to mid-teens rate. For context, Microsoft's TTM EPS is up 19.2% in the last year.
Microsoft is worth buying and holding
Microsoft is the best all-around AI play to buy now because it blends a proven track record, size, and growth. AI is driving margin expansion and fueling Microsoft's sales growth. However, AI adoption is still in the early stages.
Investors should pay close attention to Microsoft's sustained growth in its cloud business and how consumers and businesses receive its new AI-powered Copilot + PCs. If adoption is strong, Microsoft could enjoy even faster growth than anticipated.
Add it all up, and Microsoft is a medium risk/high potential reward opportunity with the best chance of being the most valuable company in the world by 2035.
