We recently published a list titled 10 Best AI Stocks With More Upside on $1.2 Trillion AI “Value Creation Opportunity”. Since Microsoft Corp (NASDAQ:MSFT) ranks 2nd in the list, it deserves a deeper look.

UBS Global Wealth Management’s (GWM) recently published a detailed report discussing different layers of the AI “value chain,” estimating the combined market value opportunity from the layers at $1.2 trillion by 2027.

UBS segments the AI market into three layers –  Enabling Layer, Intelligence Layer and Application Layer. The enabling layer is what actually powers the AI ecosystem — infrastructure, GPUs, data centers, Cloud, servers. UBS further divided this layer into two segments,  Infrastructure and Cloud. The firm expects a combined $516 billion revenue opportunity from the enabling layer by 2027.

Next up is the intelligence layer, which acts as the brain of the entire AI ecosystem. Large language models and backed software systems sit at this layer. UBS estimates that this layer presents a $225 billion opportunity by 2027.

The third layer in the AI market highlighted by UBS is the application layer. This is where the end user comes in. Cloud, data centers, GPUs, LLMs and algorithms amount to nothing if the end user cannot benefit from their huge processing power. UBS said estimating monetization opportunity of this layer was the hardest since it’s still in its very early stage. The application layer addresses actual AI software used by customers — think AI assistants, GitHub CoPilot, marketing, customer service software, etc. UBS expects a whopping $395 billion in revenue opportunities for the application layer by 2027.

Key AI Predictions

The UBS report also made key “predictions” about the AI landscape. The firm’s analysts believe the race to achieve artificial general intelligence (AGI) could give rise to a “capex cycle” that could “inflate” the AI investment bubble. UBS sees the dominance of a few companies in the AI industry will continue to be a reality moving forward, as it expects “monolithic players” and “AI foundries” prevailing in the near future.

Based on this report, let’s take a look at the top companies that will directly benefit from this $1.16 trillion opportunity by 2027. For this article we analyzed UBS analysis and picked 10 stocks that are directly exposed to the three layers in the AI ecosystem highlighted by UBS in its latest report. These companies are positioned extremely well to benefit from the monetization opportunities in the enabling, intelligence and application layers of the AI market. With each stock we have mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).

Microsoft Corp (NASDAQ:MSFT)

Number of Hedge Fund Investors: 293

Last year, The Information reported that Microsoft Corp (NASDAQ:MSFT) was working on its own AI chips under a project codenamed “Athena,” to cut its reliance on Nvidia. UBS said in its latest report that Athena chips, along with Azure, position Microsoft Corp (NASDAQ:MSFT) to benefit from the opportunities in enabling layer in the AI value chain, while the firm named the company’s OpenAI investment as an opportunity in the intelligence layer. Copilot, Office and GitHub will help Microsoft Corp (NASDAQ:MSFT) profit in the application layer of AI, UBS believes.

Many Wall Street analysts are bullish on MSFT. New Street Research started covering the stock with a Buy rating. The firm said that Microsoft Corp (NASDAQ:MSFT) is well positioned to grow profit in the “low teens for years to come” even if the AI revolution fails to pan out. New Street Research has a $570 price target on Microsoft Corp (NASDAQ:MSFT).

Analysts believe Microsoft Corp’s (NASDAQ:MSFT) AI ecosystem around its products would strengthen its Cloud division thanks to Microsoft Corp’s (NASDAQ:MSFT) integration of AI into its Cloud products. Microsoft Corp’s (NASDAQ:MSFT) Intelligent Cloud segment’s profit in the latest quarter totaled $12.51 billion, a whopping 32% growth on a YoY basis.

Microsoft Corp’s (NASDAQ:MSFT) huge investments to revive its Search business are also working. Bing’s market share has jumped to 3.64% as of April 2024, a 0.88 points gain on a YoY basis.

Wall Street expects Microsoft Corp’s (NASDAQ:MSFT) earnings to grow 12.50% next year. The  stock’s forward P/E of 31 based on 2025 EPS makes it look attractive at the current levels. Average analyst estimate for Microsoft Corp (NASDAQ:MSFT) is $483, which presents a 14% upside potential from the current levels.

Baron Fifth Avenue Growth Fund stated the following regarding Microsoft Corporation (NASDAQ:MSFT) in its first quarter 2024 investor letter:

“Our second largest purchase during the quarter was the software platform, Microsoft Corporation (NASDAQ:MSFT), which we continued to add to, after initiating a position in the fourth quarter of 2023. Microsoft continues to report strong quarterly results, with revenue growth of 16% year-over-year in constant currency thanks to better-than-expected demand in its intelligent cloud segment, which saw revenue growth of 19% year-over-year, driven by Azure growth of 28% with AI contributing 6pts to growth compared with 3pts in the prior quarter. While the adoption of GenAI remains in its early stages, Microsoft has disclosed positive initial data points with 53,000 Azure AI customers as of its December quarter up from 18,000 in the prior quarter, 1.3 million paid GitHub Copilot subscribers (up 30% sequentially) and more than 230,000 organizations who have used AI capabilities in the power platform (up 80% sequentially). Management also noted that large cloud optimizations that started a year or so ago have largely finished. Profitability also continues to be strong with 44% non-GAAP operating margins, which was 120bps better than expected.”

Overall, Microsoft Corp (NASDAQ:MSFT) ranks 2nd on Insider Monkey’s list titled 10 Best AI Stocks With More Upside on $1.2 Trillion AI “Value Creation Opportunity”. While we acknowledge the potential of Microsoft Corp (NASDAQ:MSFT), our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than Microsoft Corp (NASDAQ:MSFT) but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This article is originally published at Insider Monkey.