The FAANG acronym was coined by CNBC personality Jim Cramer in 2017, and it references a group of five technology stocks that tend to consistently outperform the broader market:
- Facebook, which now trades as Meta Platforms
- Apple
- Amazon
- Netflix
- Google, which now trades under its parent company, Alphabet
While all of those stocks remain solid investments, the market’s leadership evolved thanks to new technologies like artificial intelligence (AI). This year, Bank of America analyst Michael Hartnett assigned a name to a new group of stocks investors have focused on. It’s called the “Magnificent 7” and it includes seven of the benchmark S&P 500 index’s top performers in 2023:
The Magnificent 7 group is very similar to the FAANG group, except it includes Microsoft, Tesla, and Nvidia, and it excludes Netflix. While Microsoft is the laggard of the group this year, I’m going to explain why it might be the best long-term investment of the bunch thanks to its growing presence in AI.
Microsoft remains at the forefront of the technology industry
Microsoft is the world’s second-largest company behind Apple, with a valuation of $2.4 trillion. It’s a remarkable achievement because Microsoft was founded 48 years ago and it had to navigate several evolutions of the technology sector to remain at the top.
After starting out in software in 1975, the company built successful businesses in hardware, gaming, cloud computing, and now, artificial intelligence. The latter two go hand in hand, and the Microsoft Azure cloud platform is already serving as a distribution mechanism for some of the world’s most advanced AI products and services.
Most companies operate in the cloud by renting centralized data centers from providers like Azure, so that’s where all of their valuable data is stored. That same business model is being applied to AI; cloud platforms are building new, more advanced data centers filled with semiconductor clusters capable of handling AI workloads (mostly provided by Nvidia), allowing millions of businesses to rent the computing power they need to develop AI applications. Without that public infrastructure, the majority of enterprises couldn’t afford the cost of using AI.
In January, Microsoft invested $10 billion in OpenAI, the developer behind the revolutionary ChatGPT online chatbot. It followed a $1 billion investment in the start-up in 2019. It already integrated OpenAI’s latest technology into Azure, offering it to millions of businesses under a segment called Azure OpenAI Service. In the recent fourth quarter of fiscal 2023 (ended June 30), it already attracted 11,000 corporate customers, which was over a fourfold increase from just three months earlier.
Additionally, Microsoft used ChatGPT to develop an advanced virtual assistant called Copilot, which is now embedded into its portfolio of software products including Windows, 365, the Bing search engine, and the new Edge internet browser. These integrations were initially focused on serving consumers, but in July, the company announced an enterprise version of Copilot, so businesses can use generative AI to boost productivity in Word, Excel, and PowerPoint, for example.
Artificial intelligence could become a major contributor to Microsoft’s revenue
Ten years ago, Microsoft reported annual cloud computing revenue of just $20 billion. In the recent fiscal 2023 year, its cloud revenue surged to $110 billion with Azure accounting for more than half that number. That’s how quickly new technologies can become transformative financial contributors.
AI could have a similar impact in the coming years. Research firm McKinsey & Company predicts the technology will add $13 trillion to the global economy by 2030, and businesses that adopt it now and continue developing it could see a whopping 122% increase in free cash flow by then. On the other hand, businesses that never adopt AI could see their free cash flow shrink by 23%. If those estimates are correct, Azure is going to see substantial long-term demand for its portfolio of AI products and services from the business community.
Beyond sharing customer growth so far, Microsoft hasn’t disclosed any financials relating to its AI businesses specifically. But Oracle — which has a much smaller cloud footprint than Azure — already amassed $4 billion in commitments from AI developers for its new Gen2 Cloud infrastructure, a figure that doubled in just three months.
Azure is currently the world’s second-largest cloud platform behind Amazon Web Services, but one analyst at Wall Street firm Bernstein thinks Microsoft’s efforts in AI could eventually catapult it into the top spot.
Microsoft stock is comparatively a great value
The companies in the Magnificent 7 are mature and highly profitable, despite all of them constantly investing heavily in growth and innovation. However, investors have valued each of them quite differently.
Based on Microsoft’s $9.81 in earnings per share in fiscal 2023, its stock trades at a price-to-earnings (P/E) ratio of 32. It makes Microsoft stock about 10% more expensive than the Nasdaq-100 technology index, which trades at P/E of 30, and that’s a good reference point for the below comparisons.
Nvidia stock trades at a P/E of 108 at the moment, and Tesla stock trades at a P/E of 71. Those companies earned such high valuations because they’re growing sales at an incredible clip — Nvidia, for example, saw a whopping 171% year-over-year increase in its data center revenue in the recent quarter thanks to AI. But on the flip side, being so heavily geared toward such a new technology might create risks to Nvidia’s entire value proposition in the future if demand slows.
Microsoft lacks that lightning-quick growth, which is why it’s substantially cheaper than those other AI plays within the Magnificent 7. However, its business is far more diverse thanks to its cloud segment, its software segments, and its consumer products segments, which will insulate the company if AI doesn’t deliver as expected.
That’s why — at least for investors with a conservative to moderate risk profile — Microsoft might be the best long-term AI play in the Magnificent 7.
— Anthony Di Pizio
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Source: The Motley Fool