Microsoft (NASDAQ:MSFT) fell hard before it announced earnings on April 25, finishing the trading day below $400 per share. But thanks to blowout earnings that beat estimates things are looking up. Analysts were expecting earnings of $2.82 a share, up just 15% from a year ago, with revenue of $60.8 billion, but Microsoft stock surprised.
Instead, net income came in at $21.9 billion, $2.94 per share, and revenue was $61.9 billion. The 32% year-over-year growth of Azure cloud beat the division’s 21% average of the last three years.It was the harbinger of a new era.
The Power of AI and Microsoft Stock
Microsoft stock seemed primed for a fall because, this quarter, other cloud-related stocks fell. Nvidia (NASDAQ:NVDA) suffered a post-earnings hangover last month, shares 13% off their all-time high despite blowout earnings. Netflix (NASDAQ:NFLX) saw the same thing. Neither has fully recovered.
Even Meta Platforms (NASDAQ:META) fell 11% after beating estimates. Analysts worried about its capital spending.
It turned out Microsoft investors had nothing to worry about. AI is changing Microsoft more than the cloud itself did, CEO Satya Nadella said on its conference call.
Versions of Microsoft’s AI, like Sales Copilot, Service Copilot, GitHub Copilot and Security Copilot, will drive more revenue from each Microsoft user, he said. They’ll get it all back, and more, in productivity.
Thanks to its AI tools, the Azure cloud is taking market share from Amazon.com’s (NASDAQ:AMZN) Amazon Web Services. Microsoft Copilot is drawing millions of subscribers at $30/month, the first large language model to rack up financial success.
CFO Amy Hood said the good times should keep rolling. Through the fiscal year ending in June Azure will grow at 18-19%, she said. Copilot will help grow the Microsoft 365 business by 15%.
Activision will grow the gaming division by 40-50%, with gross margins at 50% of revenue. Once Activision is fully integrated into Microsoft it will be adding to earnings.
Microsoft has also gotten into the small model market with Phi, using smaller data sets for training. The smallest such model can fit on a smartphone. It’s an AI that doesn’t need the internet.
This is resulting in fat contracts. Coca-Cola (NYSE:KO) is putting $1.1 billion into Microsoft Azure and its AI over the next five years. Moderna (NASDAQ:MRNA) is hoping find new drug targets faster with Microsoft’s AI. Gaming revenue was also up 61%, following the Activision purchase.
Why We Worried
Before earnings the failures at Nvidia and Meta indicated an artificial intelligence hangover was taking shape. ServiceNow (NASDAQ:NOW) fell 5% despite handily beating estimates.
Azure is part of an AI arms race that saw it spending $22.7 billion in just the first half its fiscal year. The capital spending looks to be accelerating.
Analysts also worried about inflation, interest rates, and economic growth falling.
Microsoft’s valuation was also at issue. Its price to earnings ratio is 36. Its once-generous 75 cent dividend now yields just .73%. Most of its operating cash flow, which came to over $100 billion last year, went out the door as capital spending. The purchase of Activision-Blizzard left almost $57 billion in debt.
The Government Risk
The biggest risk to Microsoft now comes from the government, which has kicked the company hard before.
Microsoft lost 15 years to the U.S. vs. Microsoft antitrust case. That case hobbled Microsoft with lawyers and timid product managers until Nadella committed it to the cloud a decade ago.
The company is unbundling some of its products to address concerns. But that won’t be enough. Fears of Microsoft’s power have returned to Washington. A.J. Grotto, formerly Senior Director for Cybersecurity Policy under Obama and Trump, even called the company “a national security threat.”
The Bottom Line
I have been telling investors to buy stocks in the Cloud Czars for a decade now. Critics ask, why are they worth the premium? Why should a company like Microsoft, with a minimal dividend, be worth 36 times earnings?
The answer should now be clear to everyone. AI is the reason. It’s time to stop talking about Cloud Czars. Microsoft is the God Emperor of AI.
As of this writing, Dana Blankenhorn had a LONG position in MSFT, NVDA, GOOGL, AMZN, MRNA and NOW. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.