Microsoft’s recent achievement of becoming the most valuable global corporation, surpassing Apple, can be attributed to its embrace of artificial intelligence (AI). However, this has left investors questioning whether the upside driven by AI is justified.
With a market cap of $3.125 trillion based on Friday’s closing price of $420.55, Microsoft’s valuation is nearly double that of energy companies in the S&P 500 Index. Surprisingly, Microsoft generates only half the free cash flow of these energy companies, which has left analysts puzzled.
Free cash flow is a crucial financial metric, particularly from a liquidity perspective. It provides a realistic picture of the cash available to a company for day-to-day operations and capital investments. While profits can be easily manipulated, cash flow is a reliable indicator of a company’s financial condition.
Microsoft has witnessed steady growth in free cash flow over the years, although it flattened out in 2022 and held steady until the first quarter of 2023. However, it has been steadily climbing since then. On the other hand, energy companies, operating in a capital-intensive industry, have experienced slowing free cash flow generation. The pandemic-driven reduction in capital spending and increased production efficiency temporarily boosted their free cash flow. But with the resurgence in oil prices, energy companies are expected to increase capital expenditure, resulting in a reduction in free cash flow.
Despite debates surrounding Microsoft’s valuation, analysts anticipate the AI bubble to last for the next three to five years, which could potentially drive the stock even higher. Microsoft’s integration of OpenAI’s generative language into its business areas positions the company at the forefront of the AI revolution. Investors may be willing to assign a premium valuation to the company’s shares due to its involvement in AI.
The concept of growth stocks supports this notion, as investors trade these stocks based on the expectation of future profits and substantial capital appreciation. Microsoft’s stock ended Friday’s session up 1.56% at $420.55, indicative of the market’s confidence in the company’s AI-driven growth potential.
In conclusion, Microsoft’s leapfrogging of Apple to become the most valuable global corporation can be attributed to its embrace of AI. While its valuation may seem puzzling compared to energy companies, the anticipation of the AI bubble lasting for the next few years and Microsoft’s integration of OpenAI’s technology may justify the premium valuation assigned to its shares.
