The one AI stock to avoid

This big player is not the stock you'd expect to avoid...

I did some stock research recently, but I must fess up to something…

I cheated.

I went to Google and I typed in: “The best AI company to invest in”.

Do you want to see what the great AI in the sky, Google, sent back to me?

Source: Google search screenshot

Of course, this is exactly what you’d expect a Google search to throw up.

These are the biggest and “best” artificial intelligence (AI) companies it could scrape the internet for information about. These results are influenced by reports, essays and a seemingly endless supply of “best stocks” to invest in lists from major news and information organisations.

However, there’s a massive, glaring, disturbing problem with this.

These aren’t the best companies to invest in at all. In fact, there’s one right there, right at the top, that I argue is the worst AI investment you could possibly make and the one AI stock you should completely avoid.

That stock, the one to avoid, is none other than Microsoft (NASDAQ:MSFT).

Photo by Turag Photography on Unsplash

What is Microsoft and why is it an AI company?

Let’s be frank: if you don’t know what Microsoft is, I don’t think investing is right for you.

But just as a refresher, Microsoft – a global technology behemoth – is one of the world’s largest, most valuable and socially entrenched companies.

It is known for its computer operating systems, technology products, software and  controversial founder, Bill Gates.

However, what a lot of people don’t realise is that Microsoft also (alongside Amazon) dominates the cloud computing space. Another way to think about it is that Microsoft (and Amazon) control most of the internet.

Microsoft Azure (its cloud division) controls around 23% of the world’s cloud services market. Amazon’s market share is 32% for what it’s worth. Hence these two giants control over half of the internet through their cloud services.

It’s because of this cloud dominance that Microsoft decided to bet big on AI. Over the last few years it’s undeniable that it has made significant strides in the field of AI. Here’s a run sheet of some of the developments Microsoft has made in the AI space as of late:

• Azure AI: Microsoft's cloud computing platform, Azure, offers an extensive suite of AI services, including machine learning, computer vision and natural language processing tools. Some organisations already using this include the NBA, Airbus, the NHS and the Walgreens Boots Alliance.

• Azure Cognitive Services: Microsoft Cognitive Services provides ready-to-use application programming interfaces for adding AI features like sentiment analysis, speech recognition, and face recognition to applications. As Microsoft put it, “Cognitive Services brings AI within reach of every developer and data scientist.”

• Microsoft Copilot: Microsoft's productivity suite, Microsoft 365 (Office, Outlook, Teams) is now enhanced by AI-driven features like intelligent email filtering, real-time language translation and document collaboration powered by AI.

These are just three ways that Microsoft is rolling out AI services through its offerings. Because of this, the market is in a tizzy about Microsoft as an AI company.

However, there’s a damn good reason why Microsoft might be the worst AI stock to own, and the one AI stock I think you should avoid.

Photo by Maxim Hopman on Unsplash

Why you should avoid Microsoft as an AI play

Here’s the problem with Microsoft as a great AI play: every Tom, Dick and Harry in the investment world thinks it’s a great idea. The masses and mainstream financial media and pundits are in a tizzy about Microsoft.

Maybe over the next five years it will double in value. That’d be great. But is that really capitalising on the full potential of the AI boom?

Consider these points:

• This is a company worth US$2.4 trillion. In the last five years (during a period of rampant money-printing, incredibly low rates and a raging bull market) it has more than tripled in value. However, among some of the most energetic tailwinds in history… it’s only tripled in value. That’s not bad, but really, it’s also not extracting maximum potential from the significance of what the AI boom can deliver.

• Therefore, there’s a strong argument that Microsoft has diminished growth potential. Microsoft’s size and market saturation limit its potential for exponential growth. The law of diminishing returns suggests that achieving significant returns on investment in a mega-cap company like Microsoft is probably unlikely.

• Remember when we said Azure had a 23% market share of cloud services? Well, that’s remained constant for a few years now (give or take a percentage point or two). The question needs to be asked, can it really scale much bigger? Or is its offering at saturation? It’s not just Azure either. Microsoft’s core products, such as Windows and Office, have reached market saturation. While AI integrations may provide incremental benefits, even AI integrations are unlikely to yield explosive growth.

• Microsoft faces formidable competition in the AI space, not only from tech giants like Google and Amazon but also from nimble startups. It’s those startups and market disruptors where the exponential opportunity lies. This is where you can balance asymmetric risk in your portfolio to tap into huge profit potential. However, for Microsoft, the challenge is always going to be keeping its seat on the throne.

Asymmetric risk is important to understand here. Microsoft has been a tech giant for many years. So, the assumption is it will be on top forever. But the same was thought of about Intel… until Nvidia decimated its technology. The same was said of Ford, until Tesla came and crushed its business model. Microsoft is a stalwart of “tech”. The company is clearly forward-looking with its AI development.

With companies like Microsoft that are at the top, you need to consider the risk of staying at the top vs. the potential for them to lose market share and value to upcomers in the market. Asymmetric risk means considering smaller, riskier companies with far more exponential upside but with smaller capital allocations to not “risk the house” so to speak on such a new, innovative and risky opportunity.

Put it this way: if Microsoft doubled, to make a £1,000 return, you’d need to invest £1,000 at the start. However, for a potential AI superstar that’s relatively unknown to the market, much riskier, but with more growth potential, you might only need to invest £100 to see a £1,000 profit at the exit.

Yes, it’s riskier and it might not come off as expected, you could lose the £100, but again, you’re managing the asymmetric risk of the opportunity with appropriate capital allocations. Doing this smartly can get you exposure to the future stars of the AI boom without breaking the bank.

Do you want good or great?

When you consider all this, it’s worth balancing out what you’re looking to get out of investing in the AI boom with your overall portfolio goals.

If you want some certainty, some stability and lower risk that comes with mega-cap stocks like Microsoft, then they might fit into your portfolio perfectly if you want a way to play the AI boom. They are a good AI stock play.

You also must recognise that this might come with limited upside and yet there is still market risk that comes from incumbents and challengers to the throne. So, while they might be a good AI stock play, they are not a great AI stock play.

If you’re on the hunt for the next truly great, unknown AI superstars, small, tiny, unheralded AI-winners that are yet to fully capitalise on the market opportunity – then Microsoft would be the one AI stock to avoid.

I’m confident in saying that over the next five years I can’t see a world in which Microsoft stock grows ten times in value – that would make it a US$24 trillion company.

However, if you’re in the market for those kinds of returns, the big winners from the AI boom, it’s not Microsoft you want in the mix with your AI allocations, which makes it the one AI stock to avoid in my book.

Regards,

Sam Volkering

Editor, AI Collision

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