While my preference is to focus on small and mid-cap stocks, right now there is an opportunity in a mega-cap tech stock that appears so obvious many investors may not recognize it.
The first time I recommended this stock was in 2014. At the time I would talk about the company with relatives, friends and co-workers. The response was almost always the same.
Something along the lines of, “Yeah, sure it’s good. Reliable. Stable. But have you looked at XYZ company? I feel like they’re going to be REALLY big.”
Grrrr.
Anyway, the company I was talking about both then and now is Microsoft (MSFT). Yup, the one with a market cap of $2.4 trillion that came public back in 1986.
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Microsoft was started as a partnership between Bill Gates and Paul Allen in 1975 when the two developed a programming language for the first personal computer, the MITS Altair 8800.
Their interpreter was called Microsoft BASIC. They convinced MITS founder Ed Roberts to distribute the product. Then more contracts were signed, including with Texas Instruments (TXN), Ricoh and Apple (AAPL), in 1977.
The real break came in 1979 when International Business Machines (IBM) contacted Microsoft to develop the operating system for IBM’s PC. The resulting product, Microsoft Disk Operating System (MS-DOS), turned Microsoft from a provider of computer programming languages into a more diversified software development company.
As they say, the rest is history. But the Microsoft story is still being written.
Over the decades, Microsoft has continued to move forward with major innovations that have made its operating system and productivity tools the industry standard.
Microsoft released Azure, its cloud computing platform, in 2008. Over the following years, the company laid the groundwork for a cloud-centric business.
In 2014, when I was pounding the table on the stock, it was gaining momentum with Office 365, the cloud-based subscription version of the popular application suite. Office 365 would help the company corral a massive user base that had drifted away over the years, while also becoming a more profitable version of the perpetual license version that users downloaded about every six years.
Since November 2014 MSFT stock had delivered an average annual return of about 25% and a total return of over 600%.
Today, the company is at the front of another big transformation. The current buzz is all about Microsoft’s investment in artificial intelligence (AI), specifically ChatGPT.
As everybody knows by now, ChatGPT is a natural language processing tool developed by OpenAI. The language model can answer questions and help people complete tasks, such as writing content and code.
It is not perfect. But it is quite good. And the implications for efficiency gains for coders, content creators, etc., are massive.
That’s why ChatGPT is the fastest-growing app in history. Reports suggest it gained over 100 million active users in just two months. It took TikTok nine months to cross that threshold.
Microsoft is currently integrating the tech into many of its cloud-based tools, including its Bing search engine, Edge browser, Microsoft Teams and more. Thousands of paying customers are already using the new Teams solution.
It’s pretty easy to see how Microsoft’s already sizeable userbase will embrace the technology across multiple products AND be willing to pay more for it.
In other words, this feels like another “Office 365 moment.”
Microsoft is a massive company providing software, cloud computing infrastructure, consumer electronics and personal computers to consumers and businesses around the world.
In 2022 revenue grew by 18% to $198.3 billion while EPS grew by 16% to $9.21.
In the most recent quarter, Q4 fiscal 2023, revenue rose to $56.2 billion resulting in $212 billion of full-year revenues. Earnings per share (EPS) rose to $2.69. Both beat expectations. “AI” was mentioned 58 times on the conference call!
That result prompted a wave of upgrades and reaffirmed buys as the company’s growth outlook brightened. Analysts see revenues up another 11% in 2024.
Earnings per share should grow to $10.96 in 2024. The stock currently offers a yield of 0.8%.
Microsoft has been laying the groundwork in AI for years. It invested in OpenAI in July 2019 and has been investing in AI within Azure, GitHub Co-pilot and Microsoft Designer, among other solutions, since.
Management says Search is the largest software category in the world and that the digital ad market is worth roughly $500 billion and growing at about 18% a year.
It holds less than 5% market share. That translated into just $18 billion in 2022 ad revenue (9% of total revenue).
The number is so small because the big tree in this market is Alphabet (GOOG), which holds roughly 85% market share.
That said, Microsoft has been gaining share over the last two years. Each percentage point of share gain equates to about $2 billion of Bing revenue. Using rough math, if the company captured an additional 10% market share that’s $20 billion in revenue, enough to add roughly 10% to 2022 revenue.
It appears the cost to run all Bing search queries through ChatGPT technology will cost about $600 million to $1 billion per year, assuming no major changes to market share and computing costs (which are sure to change over time).
But again, using rough math, the cost works out to less than 0.5% of estimated 2024 revenue. This seems reasonable given the monetization opportunities of better-targeted ads and new subscription tiers across products.
I added Microsoft to the Cabot Early Opportunities portfolio in March, saying it was like a diamond hiding in plain sight, in part because of recent AI investments. The recent quarterly report helps confirm the bull case for the stock.
In my humble opinion, it is a stock to own.
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