Corporate America is heading into another important earnings season. Wall Street will be especially focused on results from the technology giants that dominate the artificial intelligence (AI) race because they tend to deliver much stronger revenue and earnings growth than the rest of the stock market.
Microsoft (MSFT -1.24%) is scheduled to release the results for its fiscal 2025 first quarter (which ended Sept. 30) on Oct. 30, and investors will be keenly focused on how well it is monetizing its growing portfolio of AI products and services.
However, there will be one AI number in Microsoft's report that could be more important than the rest.
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Microsoft's numerous AI projects will be under the microscope
Early last year, Microsoft rocked the tech sector by announcing plans to invest another $10 billion in ChatGPT creator OpenAI. It has since used OpenAI's industry-leading models to create several AI products, including its Copilot virtual assistants, which are capable of generating text, images, and even computer code in response to simple prompts.
Copilot is now embedded for free in most of Microsoft's flagship software, including the Windows operating system, the Edge internet browser, and the Bing search engine. However, the company charges an additional monthly subscription to add Copilot to its Microsoft 365 suite of productivity applications, which includes Word, PowerPoint, and Excel.
Companies worldwide pay for more than 400 million 365 seats, and all of them are potential candidates for Copilot add-ons, which presents a significant financial opportunity for Microsoft. During its fiscal 2024 fourth quarter (which ended June 30), Microsoft said the number of corporate customers that bought more than 10,000 Copilot add-ons for 365 had doubled from just three months earlier. Investors should look for updates on Copilot numbers in the upcoming quarter.
But the Azure cloud computing platform will likely headline the report, thanks mainly to Azure AI. That's the offering that allows businesses and developers to rent data center computing capacity powered by the latest chips from Nvidia and Advanced Micro Devices, in order to build their own AI models. Azure AI also offers access to the latest large language models (LLMs), including GPT-4o from OpenAI, which developers can use to accelerate the creation of AI software applications like chatbots and virtual assistants. At the end of Q4, Azure AI had 60,000 customers which was an impressive 60% increase from a year earlier.
NASDAQ: MSFT
Key Data Points
The big number that Microsoft investors need to watch
The Azure cloud platform has consistently been the fastest-growing part of Microsoft's entire organization, which is why investors tend to focus on it the most. During Q4, Azure revenue increased 29% year over year, which marked an acceleration from 26% in the prior-year quarter.
Azure's growth is increasingly driven by Azure AI. For example, Azure AI was responsible for 8 percentage points of Azure's overall 29% growth during Q4, which was a record high. That represented a whopping eightfold increase from the year-ago quarter, when Azure AI contributed just 1 percentage point to the company's top-line growth rate.
Microsoft spent a whopping $55.7 billion on capital expenditures during its fiscal 2024, most of which went toward AI data center infrastructure and chips. Management has already said it plans to spend even more in fiscal 2025.
The revenue generated by Azure AI is one way to measure the payoffs Microsoft (and its investors) are receiving for those significant financial outlays. Suppose Azure AI continues to contribute an increasing share of growth to Azure. That will indicate that businesses and developers are spending money on computing capacity and access to the latest LLMs.
Microsoft trades at a premium valuation
Based on Microsoft's trailing 12-month earnings per share of $11.80, its stock is trading at a price-to-earnings ratio of 35.5. That's a 10.5% premium to the 32.1 ratio of the Nasdaq-100 index, which includes all of Microsoft's big-tech peers.
The sheer amount of money Microsoft is spending on AI infrastructure will be a headwind for its earnings for at least the next year. Therefore, if Azure AI continues to make a growing contribution to the Azure cloud platform's results, investors will likely be more comfortable with continuing to support the stock's premium valuation. However, if Azure AI stalls or underwhelms, that could trigger a correction in Microsoft stock.
That's why, in my opinion, Azure AI's contribution to Azure's overall revenue growth is the number investors should be watching on Oct. 30.
