Artificial intelligence (AI) has been a hot trend for investors all year, and as a result, popular AI stocks have been on a tear. Nvidia is up more than 183% so far this year. Palantir Technologies has jumped more than 313%.
Meanwhile, Microsoft (NASDAQ: MSFT) -- which is heavily invested in AI through its stake in ChatGPT's parent, OpenAI -- has risen a poky 14.7%. That doesn't just pale in comparison to other AI stocks, it's a worse year-to-date return than the S&P 500, which is up 26.8%.
However, one Wall Street analyst thinks Microsoft still has plenty of upside, and he is expecting big things from the company over the next six months. Here's what he thinks the market's missing.
The analyst in question is Citibank's co-head of U.S. software equity research, Tyler Radke, who has been following Microsoft since 2021. During that time, he's gotten to know the company about as well as any outside analyst can.
Last month, Radke had a meeting with Microsoft's investor relations team and the CFOs of several of its business divisions. Afterward, he issued a note reiterating his buy rating and $497 price target on the company's stock, which currently sits at about $430 a share. His target represents a 15% upside to the share price.
More importantly, Radke expects the company's growth numbers to improve during the first six months of 2025. If he's correct, that means there's only a brief window for investors to pick up shares before the market sees the improvement and bids up shares.
Radke was impressed with Microsoft's focus on cutting costs and improving the efficiency of its operations, especially in the AI space, where the costs of ramping up have been high.
"The theme of cost optimization/efficiency was common throughout each meeting and gave us confidence the company can continue to maintain strong earnings growth through the AI investment cycle," he wrote in a note to Citibank clients.
In addition to its large investment in OpenAI, Microsoft has spent substantial resources developing its Copilot AI assistant and has now embedded it within its internal and external software, including Microsoft 365. It has also spent time training its staff to utilize Copilot to improve efficiency. Now that the software is deployed, Radke expects productivity at the company to skyrocket.
Boosting productivity, he noted in an interview with Fox Business News, used to be an excuse for layoffs, but now it's "about increasing the productivity of the people you have. You think about some of these developers: now they're 50% more productive using some of these [AI] tools like Microsoft Copilot."
The productivity gains and AI monetization may already be bearing fruit in Microsoft's Azure cloud platform. Revenue from Azure grew by 33% year over year in the most recent quarter. The company credited AI for 8% of that expansion, and has said that growth will surge in the first six months of 2025. That's thanks to previous AI-related capital expenditures and increasing capacity.
Radke believes that the high AI capital expenditures have helped to keep a lid on the stock, but that they will start paying off in 2025. He also expects to see "halo effects" from the company's AI efforts.
"The AI demand is also driving 'halo effects' as customers come for AI services but 'stay' for the platform (i.e., core Azure) that tends to be higher margin," he wrote in his note to clients.
Microsoft has been projecting that its AI efforts will start bearing fruit in the form of a revenue growth surge during the first half of 2025, and Radke agrees. Given how much the stock has underperformed its AI peers -- and especially the broader market -- this year, such a surge would likely propel shares higher, rewarding investors who buy in now.
At about 13 times sales, the company's valuation looks attractive relative to its peers, but somewhat expensive compared to its historical average, so investors may want to buy in gradually. That said, the early signs point to Microsoft being a long-term winner in the AI space.
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Citigroup is an advertising partner of Motley Fool Money. John Bromels has positions in Citigroup, Microsoft, and Nvidia. The Motley Fool has positions in and recommends Microsoft, Nvidia, and Palantir Technologies. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.