Microsoft Is Spending Big on Artificial Intelligence, but Will It Pay Off?

A big growth opportunity in tech these days is undoubtedly in artificial intelligence (AI). The entire AI market could be worth more than $1.8 trillion by the end of the decade, according to estimates from Grand View Research. That translates into a compound annual growth rate of 36.6%. For tech companies, that mouthwatering level of growth is what helps justify spending heavily on new technologies.

But there's also going to be no shortage of competition in the space. And the announcement that ChatGPT maker OpenAI will incur around $5 billion in losses this year despite generating $3.7 billion in revenue underscores how challenging it may be to turn a profit on AI, especially in the short term.

One company that's investing heavily into AI these days is Microsoft (MSFT -0.63%). Not only has it invested in OpenAI, but it's also spending money on enhancing its products and services with AI capabilities. How big of a payoff that will have on its bottom line, however, is certainly debatable.

Microsoft's capex spending has been through the roof in recent years

Capital expenditures (capex) are what a company spends to add, upgrade, or maintain its assets, for the purpose of growing the business in the long run. It's a discretionary expense and when there's a big growth opportunity, spending can ramp up significantly. In the past five years, Microsoft's capital spending has increased at a far quicker rate than revenue.

MSFT Capital Expenditures (Quarterly) data by YCharts

This isn't necessarily a cause for concern simply because the goal of increased capital expenditures is greater revenue growth down the road.

The big test will be if this high level of spend leads to an acceleration of Microsoft's growth.

Spending on AI for the sake of investing in AI won't necessarily pay off

Microsoft has the resources necessary to invest in AI, but throwing a lot of money at something doesn't mean that it's going to pay off for the business in the future. There are a growing number of AI-powered products and services in the market these days, and Microsoft will need to prove that it has superior products for that to lead to strong revenue growth.

Salesforce CEO Marc Benioff compares Microsoft's new Copilot AI to the much maligned Clippy of years past. Microsoft recently rolled out an updated version of Copilot, but if it doesn't impress business users and help justify its $30/month per user price tag for Microsoft 365, the investments the company is making in AI may not end up being worthwhile.

Should you invest in Microsoft's stock?

Shares of Microsoft are up a fairly modest 12% this year (the S&P 500 has risen by 23%) as investors may be growing apprehensive about the stock's valuation and whether AI will be the catalyst the company expects. At 36 times earnings, the tech stock is a bit pricey and its $3.1 trillion valuation means it's one of the most valuable companies in the world.

If you're investing for the long run and willing to hold on for years, then Microsoft can still make for a solid buy. Its dominance of office software products, popular Windows operating system, and expansion into gaming are all reasons why the company can continue to do well for the foreseeable future. The one wrinkle, however, is that without a high growth rate, investors may be hesitant to pay a big premium for the stock. And lackluster growth from AI could exacerbate those concerns.

I expect the company will eventually figure out what works and what doesn't with respect to AI. Microsoft can afford to make mistakes and experiment along the way. And that's why in the short run, if it underwhelms the market with its Copilot AI, it might struggle, but over the long haul the stock is still likely to rise in value.