Microsoft’s Trillion-Dollar Quarter Shows AI Trade Won’t Quit

(Bloomberg) -- With Microsoft Corp.'s best quarter for decades in the books, Wall Street is betting the stock can keep rallying as the tech giant's standing in the artificial intelligence landscape continues to improve.

The shares jumped 37.5% from July through September, their best quarterly showing since 1998, adding $1 trillion to the company's market capitalization. Microsoft also was the fifth-best performer in the technology-heavy Nasdaq 100 Index, which has gained just 0.4% over the last three months.

"After a period where it struggled with the message, Microsoft has been crisper and cleaner on how it will monetize its capital outlay and benefit its customers," said Chad Morganlander, senior portfolio manager at Washington Crossing Advisors and a long-time holder of the stock.

Much of the surge came after Microsoft's earnings in late July, which showed the fastest cloud growth in four years from strong AI demand. The stock jumped 16% the next day, its best session since October 2008, adding $450 billion in market value.

The report eased concerns about whether Microsoft's heavy AI investments would lead to better growth, which is notable because the company has a more encouraging financial profile than the other big spenders like Alphabet Inc., Amazon.com Inc. and Meta Platforms Inc. Of the four, Microsoft is the only one that hasn't seen free cash flow turn negative on an annual basis.

"It is showing a clear path to profitability with AI," Morganlander said. "As a company that is spending but not going into the red on account, it looks like the adult in the room."

Microsoft's rally is particularly impressive considering the speed of the reversal in sentiment. June was the stock's worst month since 2000, as investors questioned the company's spending and the overall outlook for software companies in an AI world. But those industry concerns have eased, and investors were encouraged by the company's effort to transform its Copilot AI assistant into a product for corporate customers.

"There are still fears of a 'SaaSpocalypse,' but it seems like Microsoft is less vulnerable to those issues," Morganlander said. "Meanwhile, people are impressed with how Copilot has been adopted and integrated."