Microsoft's Recent Earnings Reveal a Troubling Pattern for the Shares
Artificial intelligence (AI) has gave a new lease of life to numerous businesses, empowering tech firms to upgrade their existing offerings and discover innovative methods to expand operations. Venture capitalists have been actively buying stocks that are capitalizing on these opportunities. Technology titan Microsoft (MSFT -0.08%) serves as a prime example.
The company's expansion has picked up pace in the recent quarters, thanks to the introduction of AI-driven products that are boosting sales and profits. Currently, Microsoft boasts a market cap of $3.1 trillion, indicating that investing in AI seems to be reaping rewards for the organization, at least momentarily.
However, a closer examination of the company's latest financial reports reveals a trend that investors should keep a watch on. If it persists, it could pose challenges for the tech company in the imminent future.
Profit expansion is losing momentum
Many companies in the AI sector are currently experiencing a conundrum. They are extensively investing not only in the development of their new AI projects but also to promote and advertise them. Unfortunately, the payoff isn't always prompt for investors.
In Microsoft's latest earnings report, for the period ending September 30, the net income increased by approximately 11%. This is a decrease compared to previous periods and also slower than the revenue growth rate.
There are indications that Microsoft's AI may not be as impressive as many believe. The CEO of Salesforce, Marc Benioff, has compared Microsoft's AI product, Copilot, to a digital helper introduced by the tech giant in the 1990s, Clippy, which gained notoriety for being more intrusive than helpful.
As per a recent CNBC survey, about half of the companies using Copilot are either hesitant about deploying it across all their employees or are still testing the product. It hasn't lived up to the expectations of investors and analysts, failing to deliver as a standout offering.
Microsoft's stock could look even more costly if its growth decelerates further
Microsoft's stock is trading at around 35 times its trailing earnings, which isn't excessively high, considering that the typical stock in the Technology Select Sector SPDR Fund is now at a multiple of nearly 42. However, tech stocks have been trading at inflated valuations due to their impressive earnings this year. If these earnings numbers begin to decline, a correction could be imminent for these overpriced stocks, and Microsoft is no exception.
Technological research company Gartner previously predicted that many companies may ultimately abandon their AI projects as they find it challenging to prove their worth. Gartner anticipates that as many as 30% of generative AI projects may be abandoned by the end of next year.
With a looming economic recession and companies economizing on unnecessary expenses, AI investments could be under scrutiny and might become easy targets for cost cutbacks.
Should that occur, Microsoft may face more challenges next year, which could result in an even slower earnings improvement rate. Investors appear to be exhibiting caution regarding the stock: As of Monday, its year-to-date gains were only 11%, considerably below the S&P 500's impressive 26% increase in value this year.
Should you invest in Microsoft?
If you are seeking a stock to hold for several years, Microsoft can still be an attractive investment. The company's strong fundamentals, which encompass segments such as gaming and cloud computing, ensure its continued growth over the long term; this is not simply an AI-focused stock.
However, given its elevated valuation and the high expectations that come with such premiums, investors looking to purchase the stock should be prepared for a potential correction in the immediate future. This isn't a cheap stock, and there isn't much safety margin --- if any --- at present.
In light of Microsoft's financial reports, some investors might be concerned about the decelerating profit expansion, which could pose challenges for the tech company in the future. The company's valuation, currently at around 35 times its trailing earnings, is relatively high compared to the market average, making it a potential target for correction if earnings numbers decline.
Given Microsoft's focus on AI, the tech sector's tendency to invest heavily in AI projects, promote them, and the possibility of an economic recession, the company's AI projects could face scrutiny and potential cost cutbacks. Such circumstances could negatively impact Microsoft's earnings improvement rate, making it crucial for investors to closely monitor the situation.
