A new quarterly earnings season is now underway in corporate America. Next week, we will hear from some of the "Magnificent Seven" technology companies, which collectively represent almost one-third of the value of the entire S&P 500 (^GSPC -0.29%). Wall Street will be particularly focused on their progress in the artificial intelligence (AI) space, because that could be a big source of their future earnings.
On Jan. 29, Microsoft (MSFT -0.59%) will report results for its fiscal 2025 second quarter, which ended Dec. 31. Investors will be paying a great deal of attention to how well the company is monetizing its growing portfolio of AI products and services, but there is one number that could be more important than the rest.
Image source: Getty Images.
Microsoft will provide updates on several AI products
Microsoft owns 49% of ChatGPT creator OpenAI, and it has used the start-up's technology to fuel its own AI ambitions. For example, OpenAI's models form part of the foundation of Microsoft's Copilot virtual assistants, which are now embedded for free in flagship software products like the Windows operating system, the Bing search engine, the Edge internet browser, and more.
Subscribers to Microsoft's 365 productivity suite can also add Copilot to their plans for an additional monthly fee, allowing them to rapidly generate text and images in apps like Word, Excel, and PowerPoint. Organizations around the world pay for more than 400 million 365 licenses for their employees, and all of them are potential subscribers to Copilot.
During the company's fiscal 2025 first quarter, which ended Sept. 30, Microsoft said 70% of the Fortune 500 were using Copilot for 365 already, and the number of people using it daily had more than doubled from three months earlier. Investors should keep an eye out for further updates next week, because this could be a major source of new revenue for Microsoft.
But details about the Azure cloud platform will likely headline Microsoft's quarterly report once again, and Azure AI will be a big reason why. Azure has become a preferred platform for businesses seeking to deploy AI because it offers them computing power via state-of-the-art data centers, and ready-made large language models (LLMs) from leading third-party providers like OpenAI. Those are two of the key ingredients required to build AI software.
The number that investors need to watch
Azure has regularly been the fastest-growing segment of Microsoft's entire organization. During the fiscal first quarter, its revenue jumped by 33% year over year -- more than double Microsoft's overall revenue growth rate of 16%.
Azure AI is becoming an important contributor to Azure's overall growth. It was responsible for 12 percentage points of Azure's 33% revenue growth during the first quarter, which was a record high. In the year-ago period, Azure AI contributed just 5 percentage points to Azure's top-line result.
Microsoft allocated $20 billion to capital expenditures during the fiscal 2025 first quarter, most of which went toward building AI-capable data centers. That followed a staggering $55.7 billion in capex during fiscal 2024.
The revenue generated by Azure AI is one way for investors to measure the return Microsoft is seeing on that enormous spending. For example, if Azure AI continues to contribute an increasing amount of Azure's growth, then it's a positive indication that businesses are ramping up their spending on AI processing capacity and LLMs.
Why Microsoft's AI bets need to pay off
Microsoft stock currently trades at a price-to-earnings (P/E) ratio of 35.4, which is a 7.5% premium to its 10-year average of 32.9. It's also a premium to the tech-heavy Nasdaq-100 index, which includes Microsoft's big-tech peers and currently has a P/E ratio of 32.5.
MSFT PE Ratio data by YCharts.
In other words, Microsoft stock isn't cheap right now. Its massive spending on AI infrastructure is taking a bite out of its earnings, so investors might be hesitant to support its elevated valuation if they aren't seeing clear benefits from those outlays each quarter.
For example, if Azure AI's contribution to Azure's growth begins to decline, that could flip investor sentiment on its head and trigger a correction in Microsoft stock. That's why I think it's the single most important number for investors to watch on Jan. 29.
