Wall Street had a banner year in 2023. The Nasdaq Composite, which is the standard-bearer for technology stocks, shook off the effects of the bear market, soaring 43% in 2023. After a move of that magnitude, investors are wondering about the possibility of a pullback.
While those concerns are justified, history suggests a different outcome. As far back as 1972, in the first year following a market recovery, the Nasdaq has gained 19% on average, suggesting the market’s current rally has more room to run. There were a wide range of outcomes, with a lowly 7% increase in 1986 to a much more robust 38% rally in 2013. However, given the improving economy, conditions appear to be ripe for further gains.
Furthermore, recent advances in the field of artificial intelligence (AI) — which helped jump-start last year’s recovery — are only now being implemented and could fuel productivity gains in the trillions of dollars, which could drive a bull market for years to come. One company at the cutting edge of this trend is Microsoft (MSFT 1.55%). Despite gaining 57% in 2023, the company could ride these secular tailwinds to greater heights.
A potential goldmine
Microsoft was among the first to seize the opportunity represented by generative AI, and Copilot is the most high-profile example of its success. In its simplest form, Copilot is a suite of features that are deeply integrated with Microsoft’s core products, helping users be more productive.
On its recent earnings call, CEO Satya Nadella cited studies that “show as much as a 70% improvement” when generative AI tools — including Copilot — are applied to specific work tasks. He also noted that overall, Microsoft 365 users “were 29% faster in a series of tasks like searching, writing, and summarizing.” These are just a few of the many applications that have been developed for Copilot, with more joining the fold every day.
The company has made Copilot even more useful by providing out-of-the-box integrations with a wide range of third-party platforms, including Salesforce, ServiceNow, and Zendesk, among others. By expanding the functionality of Copilot to other platforms, Microsoft is also increasing its total addressable market, which bodes well for the future.
It’s still early days for generative AI, and with the rapid and ongoing shift in the landscape, it’s nearly impossible to know for sure what the opportunity could be worth to Microsoft — but that hasn’t stopped Wall Street from trying. Dan Loeb of hedge fund Third Point estimates that Copilot could increase Microsoft’s revenue by “$25 billion or more … [in] software sales alone.” Evercore ISI analyst Kirk Materne suggests AI could result in $100 billion in incremental revenue for the company by 2027.
While it could still be years before we understand the full extent of this opportunity, it’s clear that Microsoft is already profiting from AI and setting the stage for greater growth to come.
Azure continues to gain market share
The demand for AI is skyrocketing, and the most effective mechanism to deliver these services to the masses will be through the cloud. Amazon Web Services (AWS) has long led the industry it pioneered, but its growth has slowed in recent years, providing an in for Microsoft — and the company has pounced on the opportunity.
For Microsoft’s fiscal 2024 second quarter, ended Dec. 31, the company gained market share from its rivals for the second successive quarter. Azure’s Cloud revenue grew 30% year over year, faster than both AWS and Alphabet‘s Google Cloud, which grew 13% and 26%, respectively. Microsoft also noted that roughly six percentage points of that growth was the result of demand for AI services, up from three points last quarter.
This helps to illustrate how Microsoft is seizing its AI advantage to improve its financial results.
More than just AI
While AI is obviously the headliner, there are other opportunities that could boost Microsoft’s results. The economic downturn devastated Microsoft’s personal computing segment, which had historically generated nearly one-third of the company’s revenue. A recovery in the PC market has begun, and revenue for the segment just jumped 19% year over year, its highest rate of growth in nearly three years. The ongoing recovery could continue to fuel future results.
Despite its rise over the past year or so, Microsoft still has just begun to tap the opportunity represented by AI. This could, in turn, fuel growth in both the company’s software-as-a-service and cloud infrastructure businesses.
Yet for all that opportunity, Microsoft’s valuation is remarkably reasonable, selling for 37 times earnings and 13 times sales. That’s a slight premium to the overall market, but considering the wealth of opportunities ahead and Microsoft’s track record of exploiting them, a premium in this case is warranted.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Danny Vena has positions in Alphabet, Amazon, and Microsoft. The Motley Fool has positions in and recommends Alphabet, Amazon, Microsoft, Salesforce, and ServiceNow. The Motley Fool has a disclosure policy.
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