Microsoft $MSFT has been in a capital intensity mode for the last few years.But will it pay off?👇

The chart below displays some (but not all) of the key components used in calculating return on capital including the free cash flow (grey bars), property plant & equipment (green line) and goodwill (red line).

We are focusing only on these three because I would like to highlight a key question: will all of the recent capital investment pay off?

During the early 2000s, FCF regularly exceeded PPE and goodwill. Microsoft was considered a capital-light software company. However, those days are well and truly behind us. That isn't necessarily a bad thing, but it's worth watching closely as the company sells at loft valuations (more risk is embedded in the price).

$MSFT's financial statements look a lot different in the post-Covid, AI-driven tech industry. Both the PPE and the goodwill have tripled since 2020. The former indicates very strong capital investments, while the latter tells us just how active $MSFT has been with acquisitions.

However, for all of these investments made, have the FCF or OCF (operating cash flow) tripled since 2020 as well?

Well... no.

Both have barely doubled, which tells us that Microsoft's ROC (return on capital) is declining — at least for the time being and there is no sign that the current capital intensity is coming to an end, either.

Many AI contenders have entered an arms race, which is a military term originally used to describe a weapons buildup between two or more countries (think about The Cold War between the US and USSR).

However, the issue with such escalating competition is that it rarely has an absolute goal, only the relative goal of staying ahead of the other competitors — at any cost!

All sides continually eat up resources competing against each other with the hope of a winner takes all effect in the AI arms race.

However, it is worth asking whether all this capital could be spent more usefully elsewhere? And if not, could it at least be returned to shareholders in the form of dividends and/or buybacks?

Microsoft's management thinks the AI race is too important to miss out on, but time will tell whether the capital-intensive strategy, what seems to be at any cost, will pay off.