Generative artificial intelligence (AI) leans on large language models and other machine learning models to create media content like images, text, and videos. The technology had its big bang moment when OpenAI introduced ChatGPT in November 2022, and demand for such products is forecast to surge.
Bloomberg Intelligence estimates generative AI software spending will increase 2,790% to approach $320 billion by 2032, compounding at 52% annually. That puts investors in front of a significant opportunity, one that may rival the opportunity created by the internet in the 1990s.
Start Your Mornings Smarter! Wake up with Breakfast news in your inbox every market day. Sign Up For Free »
Microsoft(NASDAQ: MSFT) and Datadog(NASDAQ: DDOG) are well positioned to capitalize on growing demand for generative AI software, and both stocks come highly rated by Wall Street:
Among the 57 analysts who follow Microsoft, 91% rate the stock a buy. The median price target of $500 per share implies 18% upside from the current share price of $425.
Among the 44 analysts who follow Datadog, 88% rate the stock a buy. The median price target of $150 per share implies 18% upside from the current share price of $127.
Here’s what investors should know about Microsoft and Datadog.
Microsoft is largest commercial software company in the world due to strength in business productivity (Office), enterprise resource planning (Dynamics), and several cybersecurity verticals. The company is leaning into that strength with generative AI copilots, and early results are encouraging. Already, nearly 70% of Fortune 500 companies use Microsoft 365 Copilot, which automates tasks in applications like Word and Excel.
Beyond software, Microsoft also operates the second-largest public cloud in the world. Azure accounted for 20% of cloud infrastructure and platform services in the recent quarter, down 3 percentage points from the previous year. However, a recent CIO survey from Morgan Stanley showed Microsoft as the vendor most likely to gain share over the next three years, due in large part to strength in AI arising from its partnership with OpenAI.
Microsoft reported solid financial results in the first quarter of fiscal 2025, which ended in September 2024, beating estimates on the top and bottom lines. Revenue rose 16% to $65.6 billion on particularly strong sales growth in advertising and cloud services. Meanwhile, generally accepted accounting principles (GAAP) net income increased 10% to $3.30 per diluted share. Importantly, the recent acquisition of Activision added 3 percentage points to sales growth and subtracted 2 points from earnings growth.
During the earnings call, CEO Satya Nadella told analysts, “Our AI business is on track to surpass an annual revenue run rate of $10 billion next quarter, which makes it the fastest business in our history to reach this milestone.” He also noted that Azure OpenAI usage more than doubled during the last six months, and that AI contributed about one-third of cloud services sales growth in the recent quarter.
Wall Street expects Microsoft’s earnings to increase at 15% annually through fiscal 2027, which ends in June 2027. That makes the current valuation of 35 times earnings look a bit expensive, but Microsoft deserves a premium given its strong competitive position in the enterprise software and cloud services markets. Patient investors should consider buying a few shares today.
Datadog provides observability software that helps businesses monitor, analyze, and resolve performance issues across their IT infrastructure and applications. Its portfolio features artificial intelligence features that identify anomalies, surface insights, and automate root cause analysis. Consultancy Gartner has recognized Datadog as a leader in observability software, and Forrester Research has recognized its leadership in AI for IT operations.
Observability software becomes more important as computing environments get more complex, so the proliferation of AI systems should be a tailwind for Datadog. The company is leaning into that opportunity with LLM Observability, a performance monitoring solution for the large language models (LLMs) that power generative AI applications. Datadog also debuted a conversational assistant called Bits AI that leans on generative AI to streamline incident investigation.
Datadog reported strong financial results in the second quarter, beating estimates on the top and bottom lines. Its customer base increased 9% to 29,200, and existing customers increased their spending by more than 10%. In turn, revenue rose 26% to $690 million and non-GAAP (adjusted) net income jumped 28% to $0.46 per diluted share. But the company has hardly tapped its $51 billion opportunity in observability software, and it sees that figure growing at 11% annually through 2027.
With that in mind, Wall Street expects Datadog’s adjusted earnings to grow at 19% annually through 2027. That makes the current valuation of 69 times adjusted earnings look quite expensive. However, Datadog has topped Wall Street’s earnings estimates for 12 straight quarters, and the average estimate in the past year (as measured in dollars) was 20% too low.
In that context, the company’s earnings could grow much faster than analysts anticipate, especially as it taps demand for generative AI software with products like Bits AI and LLM Observability. Indeed, Alex Zukin at Wolfe Research opined last year that Datadog could become “the fastest growing software company” as the generative AI boom unfolds. Patient investors should feel comfortable buying a small position today.
Before you buy stock in Microsoft, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Microsoft wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you’d have $912,352!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. TheStock Advisorservice has more than quadrupled the return of S&P 500 since 2002*.
Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Datadog and Microsoft. The Motley Fool recommends Gartner and 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.
