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Microsoft: AI Potential

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Investors should shift their perspective on Microsoft (MSFT) from a seemingly conservative investment to a red-hot stock with immense growth potential. Despite its current record high, the stock’s popularity and overbought status could lead to a sharp decline. However, what many fail to realize is the transformative impact that artificial intelligence (AI) could have on Microsoft’s trajectory.

This bullish outlook stems from the decisive actions of Satya Nadella, Microsoft’s CEO, in response to a recent shake-up at OpenAI. The AI research organization is believed to be the leader in harnessing the power of AI worldwide. OpenAI’s CEO, Sam Altman, was recently ousted due to internal disputes over profits and the company’s AI utilization. In a show of support, Nadella not only offered Altman a job but also extended offers to hire the entire OpenAI team.

These swift and strategic moves by Nadella should compel investors to look beyond Microsoft’s current valuation and adopt a thematic analysis approach. This approach places a greater emphasis on the long-term impact of a trend on a business, similar to those who reaped substantial benefits from investing in Amazon.com during its early years.

Historically, the market tends to overlook anything that cannot be easily quantified in financial models. As witnessed with Amazon, it was dismissed as a losing stock for years due to its continuous losses. However, once investors recognized its strategic long game, its true value was realized.

In contrast to high-risk thematic trades reliant on solving complex challenges like addressing major diseases, Microsoft’s risks are relatively minimal. As a financial powerhouse generating substantial free cash flow, even buying the stock at record-high prices could offer exposure to AI essentially for free or at a negligible cost. With Microsoft already owning 49% of OpenAI, the potential benefits are considerable.

It is crucial for investors to envision Microsoft’s untapped potential in the AI realm. By doing so, they can capitalize on this transformative trend and unleash the true value of this already remarkable stock.

Microsoft’s Valuation: Expensive but Justified

Microsoft, with a valuation of about 36 times trailing earnings, is considered expensive compared to the S&P 500 index. However, this premium valuation seems justified due to the company’s strong fundamentals. In contrast, Nvidia, another player in the AI field, trades at around 120 times earnings.

Profiting from a Stock Market Rally

We previously recommended using Microsoft options to capitalize on a year-end stock market rally. The stock has since experienced a significant surge, resulting in substantial returns within a month.

Reassessing our Perspective on AI

Initially, we planned to allow the trades to expire profitably. However, recent moves by Microsoft’s CEO, Nadella, indicate that we may have underestimated the potential of AI due to our skepticism towards hype and media coverage.

Taking Profits and Increasing Position

If you followed our suggestion in early November to sell Microsoft’s January $325 put option for about $9.50 and purchase its January $350 call option for about $11.10, it is recommended to take profits at present. The put option is now valued at around $1.30, and the call option at $30. With the proceeds, consider establishing a larger position in Microsoft. It is crucial to be willing to hold the stock for an extended period, ideally three to five years or even longer.

At the current stock price of $373.07, investors could consider selling the March $350 put for approximately $9.50 and buying the March $385 call for around $16.50.

Risk-Reversal Strategy for Lower Stock Purchase and Potential Gains

By employing a risk-reversal strategy, which involves selling a put and buying a call with a higher strike price and the same expiration date, investors position themselves to purchase the stock at a lower price while participating in gains above $385.

The March expiration allows ample time for investors to reassess Microsoft’s stock positively and contemplate the underlying message conveyed by Nadella’s recent actions.

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