Bill Ackman's Pershing Square Made Microsoft Its Largest AI Holding by Selling Alphabet. Here's the Thesis Behind the Switch.

When considering the stock market, it sometimes pays to look at what some of the nation's most prominent investors are up to. One of those is Bill Ackman, the billionaire investor and CEO of Pershing Square Capital Management. Pershing, which typically keeps its portfolio confined to a small group of large-cap companies, has been a consistent investor in "Magnificent Seven" tech stocks, with Alphabet, Amazon, Meta Platforms, and Microsoft (NASDAQ: MSFT) all holding prominent weightings at one time or another.

But there were some notable changes in the second quarter -- Ackman trimmed his position in Amazon by 25%, or 2.9 million shares, sold his entire stake of Alphabet, and bought another 553,000 shares of Microsoft stock. Those moves make Microsoft Ackman's biggest AI bet, with a $2.3 billion position that includes 6.2 million shares, representing 11.9% of the company's 14-stock portfolio.

Why are Ackman and Pershing so bullish on Microsoft? And does it belong in your portfolio as well?

Pershing Square Capital Management CEO Bill Ackman. Image source: Getty Images.

Timing is everything

First, give Ackman some credit: Pershing's Microsoft purchase was well timed. Microsoft posted huge gains at the end of July when it issued its fiscal fourth-quarter earnings report, and has gained 25% since.

Microsoft's quarterly revenue was up 18% from a year ago to $90 billion, and net income was up 31% to $35.76 billion. For the full fiscal year, Microsoft reported $100 billion in Azure cloud revenue.

Also critically important for investors: Microsoft still managed to generate $19.6 billion in free cash flow (FCF) and projected it will remain free-cash-flow-positive in fiscal 2027. That's huge, considering AI companies are struggling to remain FCF positive. Alphabet had negative FCF of $5.9 billion in its most recent quarter, while Amazon had negative FCF of $7.6 billion.

In its June interim report, Pershing outlined its bullish sentiment toward Microsoft, citing the popularity of its 365 suite of software applications, such as Word, Excel, and PowerPoint, and the growth of Microsoft Azure.

"With direct involvement from CEO Satya Nadella, the company has redoubled Copilot product innovation and growing adoption should further entrench M365 as agentic work scales," the report said. "In our view, Azure, the second largest public cloud hyperscaler, is well positioned in a supply constrained compute market, and its capital expenditures are prudent investments to accelerate growth."

Microsoft's strong growth, positive free cash flow, and increasing demand for Azure help explain why Pershing now has Microsoft as its top AI stock. Its established collection of highly profitable businesses and productivity apps will enable Microsoft to continue investing in AI while generating profits for shareholders.

Patrick Sanders has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Meta Platforms, and Microsoft. The Motley Fool has a disclosure policy.