Microsoft (MSFT -1.32%) has rewarded investors nicely in 2023. Shares of the software giant have jumped 38% as of this writing, and the stock seems capable of delivering more gains based on the takeaways from its latest quarterly report.
Microsoft released fiscal 2024 first-quarter results (for the three months ended Sept. 30) on Oct. 24. The company's revenue and earnings easily crushed Wall Street's expectations. Microsoft's earnings jumped 27% year over year to $2.99 per share on a revenue jump of 13% to $56.5 billion. Analysts would have settled for $2.65 per share in earnings on revenue of $54.5 billion.
However, a towering performance from Microsoft's cloud business last quarter drove its number past expectations, driven mainly by the growing adoption of the company's artificial intelligence (AI) services. A closer look at the performance of Microsoft's cloud business last quarter tells us that AI has started moving the needle in a tangible way for the company, and it could turn out to be a big catalyst for the stock over the next three years.
Let's see why that may be the case.
AI has started moving the needle for Microsoft
Microsoft's revenue from the Intelligent Cloud business jumped 19% last quarter to $24.3 billion. More specifically, the Azure and other cloud services segment within the cloud business delivered stronger year-over-year gains of 29%.
Intelligent Cloud is the unit where Microsoft includes its revenue from AI products and solutions. The company precisely quantified the impact of this fast-growing technology on its cloud business last quarter.
According to CFO Amy Hood on the company's latest earnings conference call, "Azure and other cloud services revenue grew 29% and 28% in constant currency, including roughly 3 points from AI services."
Microsoft management admitted that it saw stronger-than-expected adoption of its AI offerings last quarter.
Analysts were expecting Azure and other cloud services revenue to increase 26.2% year over year, which means that AI played a key role in helping the company deliver better-than-expected results.
Even better, AI is all set to drive stronger results for Microsoft, both in the short and the long run. This is evident from the company's outlook for the current quarter, which calls for $60.9 billion in revenue, compared to Wall Street's estimates of $58.7 billion.
Microsoft management points out that it expects Azure and other services revenue to grow "26% to 27% in constant currency with an increasing contribution from AI." That wouldn't be surprising as the company continues to integrate AI into more of its offerings.
For instance, the company's AI-powered Microsoft 365 Copilot will be made generally available for enterprise customers starting Nov. 1.
The company will be charging $30 per user per month from its enterprise customers for this suite of solutions, which are designed to drive productivity gains by infusing AI into popular applications such as Word, Excel, PowerPoint, Teams, Outlook, and more.
Microsoft claims that 365 Copilot has already been used by "tens of thousands of enterprise users" during the pilot phase at big companies such as KPMG, General Motors, Visa, and others.
So it wouldn't be surprising to see this new product quickly gain traction and start contributing to Microsoft's business. What's more, Microsoft says that its Azure cloud service is gaining share in the cloud infrastructure market thanks to AI.
Management points out that its Azure OpenAI service is being used by more than 18,000 organizations globally. That number could keep rising, as Microsoft claims that it has deployed AI services in more regions than any other cloud service provider.
Investors should note that Microsoft's rival Alphabet reported a 22% year-over-year increase in Google Cloud revenue last quarter to $8.4 billion. That was slower than the pace Microsoft Azure grew last quarter, indicating that the company may indeed be taking share away from rivals in the multibillion-dollar cloud infrastructure market.
This bodes well for Microsoft's future, as the adoption of cloud-based AI services is expected to grow at an annual pace of 36% through 2032, according to Allied Market Research. The researcher estimates that the cloud AI market could generate a whopping $887 billion in annual revenue in 2032, compared to $42 billion last year.
It isn't too late to buy the stock
Analysts are expecting an acceleration in Microsoft's growth from the current fiscal year. The company finished fiscal 2023 with $212 billion in revenue, an increase of 7% over the previous year. The following chart indicates that it could deliver double-digit top-line growth, followed by stronger gains in the next couple of fiscal years.
MSFT Revenue Estimates for Current Fiscal Year data by YCharts
Microsoft stock trades at 11.3 times sales at this writing, which is slightly higher than its five-year average sales multiple of 10.4. However, the multiple seems justified given the potential acceleration in its growth. Assuming Microsoft maintains a price-to-sales ratio of 10 in three years and hits $313 billion in revenue as per the chart above, its market cap could jump to just over $3.1 trillion.
That points toward a 27% upside from current levels. But don't be surprised to see this AI stock delivering stronger gains if the market rewards its faster growth with a richer multiple.
