AI, is it really capable? This week, Microsoft may welcome its most important earnings report in history.

The AI hype that continues to generate buzz has propelled tech giant Microsoft to new heights. Year-to-date, Microsoft's stock price has risen by 44%, with a market value increase of nearly $800 billion. Its PE-TTM ratio has exceeded 31 times, far surpassing the market average of 20 times.

However, how much impact AI has on the business and how quickly the substantial investment can translate into tangible revenue remains to be seen. What is the potential for future growth? Analysts on Wall Street are closely monitoring Microsoft's performance.

After the US stock market closes this Tuesday, Microsoft will release its Q4 and full-year fiscal report for FY23 (Microsoft's fiscal year runs from July 1 to June 30). The answers will be revealed at that time.

Wall Street Analysts are Mostly Optimistic

The majority of Wall Street analysts have a positive outlook on this tech giant. According to CNBC data, 85% of analysts rate Microsoft as hold, buy, or overweight.

Leading up to the earnings release, several institutions have raised their target price for Microsoft, with the current average target price at $373, implying a potential upside of approximately 10%.

Last Friday, Goldman Sachs analyst Kash Rangan raised the target price for Microsoft to $400. He believes that the potential market size in AI-related fields could reach $135 billion, and Microsoft is poised to capture 15%-30% of that market by 2026.

Citigroup analyst Tyler Radke also raised the target price for Microsoft to $425 last week. He believes that Microsoft's Copilot has tremendous potential, and even with a penetration rate of only 5%, the product could generate at least $5 billion in incremental revenue for Office 365, which is close to half of last quarter's enterprise sales revenue ($9.4 billion).

Nancy Tengler, Chief Investment Officer at Laffer Tengler, stated to CNBC:

"I don't think this is hype. I think they can monetize it. Almost everyone believes that generative AI will be key for the next several decades, and I think Microsoft is far ahead of everyone else."

Expensive Development and Maintenance of AI? Capital Expenditure Could Significantly Impact Microsoft's Performance

AI applications integrated into the Office suite, such as Copilot, which offers magical features like "one-click PowerPoint generation," have received unanimous praise from industry observers.

Many analysts expect that through AI software services, Microsoft can significantly increase its revenue and create a new growth curve.

However, the pricing of Copilot at $30 per user per month has raised doubts about its profitability and attractiveness to users. Last Wednesday, Guggenheim analyst John DiFucci stated in a report that the pricing of Copilot was "unexpectedly high."

Technology investor Paul Meeks also believes that the pricing of Microsoft Copilot is too aggressive and may exceed the budget of many ordinary users. He believes that if Microsoft cannot significantly improve its revenue guidance and growth expectations in this earnings report, the stock price may decline.

In addition, the growth of Microsoft's cloud computing business is also a key concern for analysts.

In a recent report by Wolfe Research analyst Alex Zukin, he pointed out that as Microsoft delves deeper into the field of AI, the market's focus will shift from "what is good enough" to "how good can it be."

Alex Zukin believes that Microsoft Azure is expected to achieve a revenue growth of 27.5% this quarter. He noted that Azure is gaining market share from the AI boom. He expects that Azure's revenue will accelerate in this quarter and the first quarter of fiscal year 2024, with a year-on-year revenue growth rate of 30% by the end of this year.

However, the computational resource pressure brought by the AI boom also means that Microsoft's capital expenditure may increase significantly in order to keep up with the growing market demand, which may drag down its performance. Microsoft executives also issued a warning during the last quarter's earnings conference call, stating that capital expenditure on AI in the fourth quarter will increase significantly.

Microsoft's capital expenditure for fiscal year 2023 is expected to be $32 billion, accounting for 13.5% of estimated revenue. However, according to Jefferies analyst Brent Thill's estimation, Microsoft's capital expenditure may reach as high as $35 billion to $40 billion, accounting for 15% to 17% of estimated revenue. The high costs associated with the development, hosting, and service of Microsoft's AI products may weigh down its performance.