Better Buy: Microsoft vs Alphabet

Microsoft (MSFT -4.18%) The parent company of Google the alphabet (The Google -3.72%) (Google website -3.72%) Both yielded impressive gains for impatient investors. Over the past five years, Microsoft’s stock has nearly quadrupled as it has significantly expanded its cloud-based services and mobile apps. Alphabet stock is up nearly 170% as Google advertising company, its cloud platform, and YouTube all go roll.

However, both stocks are down about 20% this year as inflation, rising interest rates, and other macroeconomic headwinds have rocked the market. Should investors consider investing in any of the tech giants now?

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Microsoft’s cloud business continues to grow

Microsoft’s revenue rose 18% to $168.1 billion in fiscal year 2021 (ended June 30), as earnings per share (EPS) increased 40%. The tech company initially faced slowing demand for software and services facing enterprises as the pandemic spread, but subsequent actions to stay at home generated a tailwind for its cloud-based services and Xbox and Surface gaming business.

Cloud’s total revenue increased 34% to more than $69 billion for the full year, which represented 41% of its net profit. This growth was primarily driven by the Microsoft Azure cloud infrastructure platform, the Office 365 productivity suite, and the Dynamics 365 customer relationship management (CRM) platform. Operating margin also jumped 460 basis points to 41.6%.

This momentum continued into fiscal year 2022. The tech giant’s revenue rose 20% year-over-year to $164.4 billion in the first nine months of the fiscal year as total cloud revenue increased more than 30% over all three quarters. Operating margin rose 120 basis points to 42.9%, and earnings per share grew 26% — even as the company incurred some investment-related losses in the third quarter.

For the full year, analysts expect Microsoft’s revenue and profit growth of 18% and 16%, respectively. In the next fiscal year, they expect Alphabet’s revenue to increase 14% and profits to jump 15%.

After the recent sell-off, Microsoft stock is currently trading at a reasonable 25 times forward earnings, paying a forward yield of 0.9%. It also returned 61% of the $20 billion in free cash flow to investors through buybacks and dividends in its most recent quarter.

Alphabet faces more headwinds in the near term

Alphabet revenue increased 41% to $257.6 billion in 2021. Its advertising activity intensified as headwinds associated with the pandemic faded, and the company benefited from an easy comparison of the initial impact of the pandemic in 2020. Operating margin expanded seven percentage points to 31% and earnings per share rose by 91%.

The company’s various sectors individually flourished in 2021. Google’s advertising revenue rose 43% to $209.5 billion over the year. Google Cloud, which has been Alphabet’s primary growth driver throughout the pandemic, increased its revenue 47% to $19.2 billion.

However, Alphabet’s growth slowed slightly in the first quarter of 2022 as that recovery faded after the shutdown. Total revenue increased 23% year over year to $68.01 billion, and operating margins remained flat at approximately 30%. EPS was down 6%, but just like Microsoft, that drop was due to investment-related losses rather than significantly higher operating expenses. Google’s advertising revenue rose 22% to $54.6 billion in the first quarter of 2022. Google Cloud revenue also rose 44% to $5.8 billion.

Analysts expect Alphabet’s revenue and earnings to grow 18% and 3%, respectively, this year. Next year they expect to increase its revenue and profit by 16% and 18%, respectively. Based on these forecasts, Alphabet stock looks historically cheap with only twenty times forward earnings.

Alphabet does not pay a dividend, but it has spent 58% of the $89 billion in FCF on buybacks over the past 12 months. It also added another $70 billion to its buyback plan – which means its stock is still cheap at these levels.

Best Buy: Microsoft

Both Microsoft and Alphabet are great buys at these prices. But if I had to pick one over the other, I’d stick with Microsoft for three simple reasons: its business is better diversified, its cloud business is bigger, and it’s not as sensitive to macroeconomic headwinds as Google’s ads business.

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