Investing in artificial intelligence (AI) stocks may seem tricky given multiple companies are eying to gain traction in a rapidly expanding addressable market. Several players are investing heavily to enhance their AI capabilities and benefit from an early-mover advantage. So, long-term investors may consider gaining exposure to the AI sector by holding shares of mega-cap companies such as Microsoft (NASDAQ:MSFT). Let’s see why.
Microsoft is well-diversified
Valued at US$3 trillion by market cap, Microsoft is the largest publicly listed company in the world. It operates in several business segments that include the following:
- Productivity and Business Processes: It offers products such as Microsoft Office, Teams, and the 365 copilot, as well as revenue from LinkedIn.
- Intelligent Cloud: The business offers server products and cloud services, including Azure.
- Personal Computing: The segment includes revenue from Windows as well as from the gaming vertical, such as Xbox and Activision Blizzard.
Strong performance in fiscal Q4
In fiscal Q4 of 2024 (ended in June), Microsoft reported revenue of US$64.73 billion with adjusted earnings per share of US$2.95, compared to estimates of US$64.39 billion and US$2.93, respectively. The company’s sales rose by 15% year over year in Q4, which is exceptional for such a large entity.
In fiscal Q1, the tech giant forecast sales between US$63.8 billion and US$64.8 billion, indicating a year-over-year growth of almost 14% at the midpoint estimate. However, analysts forecast Q1 sales at US$65.24 billion for Microsoft, dragging the stock lower following its outlook.
Microsoft’s Intelligent Cloud business generated US$28.52 billion in revenue, rising 19% year over year but below estimates of $28.68 billion. Microsoft stated that revenue from Azure and its cloud services rose by 29% year over year, which was below growth estimates of 31%. The public cloud segment is dominated by three major players: Amazon, Microsoft, and Alphabet, all of which are expanding their AI workload capabilities.
The three tech behemoths are allocating significant resources toward AI, which will be a key revenue driver in the future. According to Microsoft, eight percentage points of the 29% growth in its cloud services came from AI services. Microsoft expects fiscal Q1 sales growth for Azure between 28% and 29% with revenue expected to accelerate in the second half of the fiscal year.
Additionally, six years ago, Microsoft acquired GitHub, which ended fiscal 2024 with an annual run rate of more than US$2 billion.
Dividend and valuation
Microsoft stock has returned 840% to shareholders in the past decade. After adjusting for dividends, cumulative returns are closer to 1,000%. Microsoft pays shareholders an annual dividend of US$3 per share, which translates to a forward yield of 0.74%.
Microsoft ended fiscal 2024 with a free cash flow of US$58.56 billion or US$9.97 per share, which indicates its payout ratio is just over 30%.
MSFT stock might seem expensive at 31 times forward earnings. However, analysts forecast its earnings to expand by 14.6% annually in the next five years. Analysts remain bullish on MSFT and forecast it to gain over 35% from current levels.
