The Dow Jones Industrial Average is underperforming both the Nasdaq Composite and the S&P 500 in 2023. But that’s certainly not because of the tech stocks in the Dow.

At the time of this writing, the top-four best-performing Dow stocks so far this year are all tech stocks. Salesforce is up 89% year to date (YTD), Intel is up roughly 59%, Microsoft (NASDAQ: MSFT) is up 55%, and Apple is up roughly 49%.

Microsoft has taken the market by storm thanks to the artificial intelligence (AI) megatrend. Like most trends, there are a lot of opportunities for investing in AI. But there are also a lot of hype stories that may have more risk than potential reward.

Unlike other AI companies that flaunt hypothetical gains, Microsoft is implementing AI and achieving real-world results as we speak. Here’s why Microsoft is an AI stock worth buying now and why it can follow up its historic 2023 performance with another great year in 2024.

Image source: Getty Images.

Integrating AI into proven solutions

The theme of Microsoft’s first-quarter fiscal 2024earnings callin late October was undoubtedly AI. And for good reason.

Microsoft has the best short-term and long-term opportunities when it comes to AI. The short-term opportunity is integrating AI into existing business-to-consumer and business-to-business solutions — basically making its products and services more useful and justifying higher subscription prices and increased adoption. The long-term opportunity involves honing the power of AI across its existing offerings to gain a bigger leg up over the competition and developing entirely new solutions.

A relatable example of how AI is improving existing Microsoft solutions is Microsoft Copilots. Copilots are generative AI that are integrated into existing applications. Generative AI, like ChatGPT, uses text, images, media, and language models to create new content. For example, there are Microsoft Copilots for Word, PowerPoint, and Excel. There’s a Copilot for the Microsoft Edge web browser. There’s even a Copilot for the software-development app GitHub.

Microsoft is producing results

Releasing new AI tools means little if folks aren’t using them. But the data shows that Copilots are having an immediate impact. Here’s what Microsoft CEO Satya Nadella said about GitHub Copilot on the company’s Q1 fiscal 2024earnings call

With GitHub Copilot, we are increasing developer productivity by up to 55% while helping them stay in the flow and bringing the joy back to coding. We have over 1 million paid Copilot users and more than 37,000 organizations that subscribe to Copilot for business, up 40% quarter over quarter, with significant traction outside the United States. This quarter, we added new capabilities with GitHub Copilot Chat, which are already being used by both digital natives like Shopify, as well as leading enterprises like Maersk and PwC to supercharge the productivity of their software developers. All of the number of developers using GitHub has increased 4x since our acquisition five years ago.

Microsoft has a captive audience that acts as a feedback loop for determining whether its solutions are useful or not. Oftentimes, tech companies spend too much time building the perfect solution instead of ensuring that the solution will gain traction and be used. Microsoft is unique because it is exposed to different audiences with different skill sets and needs. The needs of Microsoft Word users are far different from those of developers using GitHub, or gamers using an Xbox and playing one of the many gaming franchises Microsoft owns. The AI consumption and tools needed for Microsoft’s cloud business and Azure will vary from its other products. The list goes on and on.

The takeaway here is that there are ways for Microsoft to monetize AI across everything it already does, which unlocks growth from proven solutions without even accounting for the new markets and products that Microsoft either organically develops or enters through acquisitions. Nadella put it well during his keynote speech at Microsoft Ignite 2023:

We’re entering this exciting new phase of AI where we’re not just talking about it as technology that’s new and interesting, but we’re getting into the details of product making, deployment, safety, real productivity gains, all the real-world issues. And that’s just the most exciting thing for all of us as builders. We are at a tipping point. This is clearly the age of Copilots.

Margin for error

Not only does Microsoft have a swath of solutions that it can readily integrate AI into, but it also has the cash flow needed to fund growth and absorb mistakes. In fiscal 2023, Microsoft generated $59.5 billion in free cash flow (FCF), spending $20.4 billion on buybacks and $19.8 billion on dividends. Buying back stock is an excellent way to reduce the outstanding share count and grow earnings per share — if a company has limited growth opportunities. But Microsoft has plenty of growth opportunities, so cutting back on stock repurchases and devoting more FCF toward growth is a card Microsoft can play when needed.

In the meantime, the company is generating more FCF than it needs to support sizable buybacks and its dividend program. And to top it all off, the company has more cash and cash equivalents on its balance sheet than debt. So if there’s an acquisition opportunity, Microsoft can lean on its balance sheet to make it happen.

An AI stock you can count on

Microsoft is the perfect medium-risk/high-potential reward AI stock. I’m saying medium-risk instead of low-risk due to Microsoft’s expensive valuation.

Sure, there are plenty of riskier, smaller companies out there that could easily outperform Microsoft stock. But no company has the existing market position, opportunity to integrate AI into what it already does, deep pockets, and financial profile of Microsoft. Microsoft can afford to make mistakes, and more importantly, take risks when other companies have no wiggle room. It also has an unparalleled pulse on the consumer and industries. In this vein, Microsoft has as close to a crystal ball as you can find when it comes to predicting what customers are going to want from AI and what they aren’t going to use.

Microsoft isn’t a cheap stock. But it has what it takes to grow its earnings and support a higher valuation. For that reason, Microsoft could continue to beat the market in 2024 and for years to come.

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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Microsoft, Salesforce, and Shopify. The Motley Fool recommends Intel and recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, and short February 2024 $47 calls on Intel. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Original: MSFT Feed: One of This Year’s Top-Performing Dow Stocks Could Continue Its Hot Streak in 2024