If Microsoft Get This One Thing Right, the Stock Could Explode

Key Points
Microsoft has fallen behind in the AI race.
Copilot, its AI assistant, has been widely derided.
A successful AI model could solve many of Microsoft's problems.
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Microsoft (NASDAQ: MSFT) was an early winner in the AI boom. Its partnership with OpenAI put it in the pole position after ChatGPT launched in late 2022.
However, more than three years later, Microsoft is looking like a laggard in AI. Copilot, its AI assistant, has received broad criticism for its high price tag, relatively poor performance, and low adoption rate, evidence that Microsoft squandered the advantage it had with its partnership with OpenAI.
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This year, Microsoft stock has tumbled on fears that its enterprise software empire could be disrupted by AI-native products, using new tools like Anthropic's Claude Code.
Year-to-date, the stock is down 23%, and it's off by more than a third from its peak. With a market cap below $3 trillion, Microsoft's share price has not been this low since 2023, with the exception of a brief drop following the Liberation Day tariffs announcement a year ago.
Microsoft's slide has come even as the business has continued to deliver strong results. In its most recent quarter, revenue rose 17% to $81.3 billion, and adjusted earnings per share were up 24%. Revenue from Azure, its cloud infrastructure service, jumped 39%.
In other words, Microsoft's business remains strong, but investor perception of the company's prospects has dramatically declined.
Microsoft may now have an answer for that.
Can Microsoft catch up in AI?
After mixed results in its partnership with OpenAI and the Copilot flop, Microsoft is now preparing to develop its own frontier models, bringing it into competition with leaders like OpenAI, Anthropic, and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), according to a Bloomberg interview with Microsoft's AI chief, Mustafa Suleyman.
Microsoft plans to create state-of-the-art AI models by 2027, to generate text, audio, and images.
If Microsoft is able to find success with those models, it could solve virtually all of the stock's problems, including the weakness with Copilot and its vulnerability to AI disruption. A better AI assistant or chatbot would almost make products like Microsoft 365 stickier and allow the company to charge more for those products.
As an example, Alphabet's surge last year came in large part due to the recognition for Gemini, its new AI model, which some consider to be better than ChatGPT.
For Microsoft, just recovering to its previous peak would represent a gain of roughly 50%.
Will Microsoft get there?
Whether Microsoft will challenge companies like OpenAI and Anthropic depends on its execution, but the tech giant should have the expertise and the funds to get there.
We'll learn more as Microsoft makes progress toward that goal, but shares of the Windows-maker could prove to be a bargain if it can execute on that goal.
Should you buy stock in Microsoft right now?
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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and Microsoft. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.