• Microsoft to announce its Q4 earnings on July 30 after the market close

• Has the AI boom run its course or is this revenue surge sustainable?

• Cloud growth and AI spending will be under scrutiny amid high valuation

Monetizing AI

Microsoft Corp continues to ride high on the artificial intelligence (AI) wave, having been among the first to bet big on the AI revolution. The Company’s investment in ChatGPT maker OpenAI, thought to be in the region of $13 billion, so far seems to be paying off. Revenue growth was in double digits in each of the previous three quarters, while earlier this year, Microsoft overtook Apple as the world’s most valuable company for the first time since 2021.

Adding to the optimism ahead of the fourth quarter earnings announcement is the recent launch of the latest generation of Surface personal computers (PC) – the first to be fitted with Copilot+, bringing AI functionality and performance to the masses.

Copilot+ PCs follow on from the launch earlier in the year of Copilot Pro, which is the subscription version of the free Copilot that offers added AI features. Microsoft’s ability to not only implement AI in its products and services but to also show to investors that it’s able to monetize its investments in AI has been key in maintaining the AI-fuelled rally, as well as the positive earnings outlook.

Is earnings boom coming to an end?

But as more time passes and as rivals such as Apple announce competing AI plans, the pressure is on for those ahead of the race to deliver on the hype. Looking at the revenue forecasts, Microsoft will probably not disappoint. Revenue is expected to have increased to $64.24 billion in the fourth fiscal quarter – a rise of 14.3% from the same period a year ago.

However, earnings per share (EPS) might reflect slowing profitability. According to LSEG IBES data, EPS is projected to have grown by $2.91 in Q4, down from $2.94 in the prior quarter and up just 8.2% from the corresponding period in 2023 versus growth of 20% or more in each of the previous four quarters.

AI spending spree not yet over

One reason for the expected slowdown in profit growth is the increased expenditure on new investments, particularly on AI infrastructure for its cloud services. However, this is something that Microsoft had already warned investors about and therefore, it’s unlikely to come as too much of a surprise. Nevertheless, the focus will be on its Azure cloud computing unit, specifically, whether cloud income kept up pace with previous quarters.

Cloud services remain by far Microsoft’s biggest source of revenue growth as well as being the largest single segment. Any signs that demand is waning, not just for its cloud unit but also for its other products and services such as Office 365, could add to the selling pressure hitting the stock this week.

A temporary pullback?

Microsoft’s share price is close to breaching its 50-day moving average (MA) amid a broader correction in tech stocks. A drop below it would bring into range the $400.00 level where the 200-day MA is about to intersect.

A downbeat guidance about the next quarters could also send the stock plunging. But if the Company posts better-than-expected results or at the very least, retains an upbeat view on its AI ventures, the stock could rebound towards its recent all-time high of $468.35 before setting sights on the $500.00 mark. That’s somewhat above analysts’ median price target of $490.00, although they all maintain their ‘buy’ recommendation.

Not too expensive, not too cheap

From a valuation perspective, Microsoft is only slightly more expensive than the average tech firm in the Nasdaq Composite and it fares reasonably well among the Magnificent 7 when comparing their trailing price/earnings (PE) ratio. It also ranks somewhere in the middle when it comes to 12-month forward multiples.

This suggests that Microsoft isn’t necessarily more vulnerable than its rivals to a tech selloff, but with its forward PE higher than those of Apple, Alphabet and Meta, investors have more good news priced in than for some of the AI laggards. And with the Company planning on spending even more on AI over the next few years, the stakes are about to get even higher.