MSFT: Microsoft vs. Alphabet: Which Stock is a Better Buy?

Microsoft Corporation (MSFT) and Alphabet Inc. (GOOGL) are two of the most prominent and successful players in the technology industry. They have thrived amid the coronavirus pandemic, which has created a boom in digital communications, shaping the future of enterprise software solutions with their cloud-based offerings.

MSFT develops, licenses, and supports software, services, devices, and solutions worldwide. The company’s products include operating systems for computing devices, intelligent devices, server, productivity and business solution applications, desktop and server management tools, and software development tools. These products enable companies’ digital transformation in the era of cloud computing. MSFT operates through three segments – Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

GOOGL offers performance and brand advertising services worldwide. The company operates through Google and Other Bets segments, and offers products such as Ads, Android, Chrome, Google Cloud, Google Maps, Google Play, Hardware, Search, and YouTube, as well as technical infrastructure. The Other Bets segment includes businesses such as Access, Calico, CapitalG, GV, Verily, Waymo, and X, as well as internet and television services.

Both the stocks generated good returns over the past five years. While MSFT returned 287.2% over this period, GOOGL gained 138.5%. In terms of year-to-date performance, MSFT and GOOGL have risen 37% and 36%, respectively.

But which of these stocks is a better pick now? Let’s find out.

Latest Movements

MSFT recently announced a global collaboration with Johnson Controls International (JCI), a global leader in smart and sustainable buildings, to integrate OpenBlue Digital Twin and Azure Digital Twins. The initiative seeks toto encompass the entire ecosystem of building and device management technologies. In October, in collaboration with C3.ai and Adobe (ADBE), MSFT launched C3 AI CRM, the first enterprise-class, AI-first customer relationship management solution purpose-built for industries. It integrates Adobe Experience Cloud and delivers customer-facing operations with predictive business insights.

GOOGL is rapidly expanding its Cloud segment’s edge computing to help companies leverage AI and 5G. The company recently finalized a strategic, multi-year partnership with Deutsche Bank (DB) to accelerate the bank’s transition to the cloud and co-innovate new products and services. It is the first partnership of this kind to serve the financial services industry.

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GOOGL has reportedly acquired Dataform, a UK-based startup that helps businesses manage data warehouses. However, the terms of the deal have not yet been disclosed. The company earlier this month also entered into an agreement to acquire Actifio, a leader in backup and disaster recovery.

Recent Financial Results

In its fiscal first quarter that ended September 2020, MSFT’s revenue surged 12% year-over-year to $37.2 billion on back of Office Consumer products and cloud services revenue grew 13%. Microsoft 365 Consumer subscribers increased to 45.3 million during the quarter. The company’s EPS grew 32% year-over-year to $1.82.

GOOGL’s revenue for the third quarter ended September 2020 grew 14% year-over-year to $46.17 billion. This growth was primarily led by an increase in advertiser spend in Search and YouTube. as well as its continued strength in Google Cloud and Play. GOOGL’s EPS grew 62% year-over-year to $16.40.

Here GOOGL is in an advantageous position.

Past and Expected Financial Performance

MSFT’s revenue and EPS have grown at a CAGR of 14% and 22.5%, respectively, over the past 3 years. The CAGR of the company’s free cash flow has been 34.4%.

Analysts expect the company’s revenue to increase 8.9% in the current quarter, 10.6% in the current year and 11.1% next year. MSFT’s EPS is expected to grow 8.6% in the current quarter, 17.4% in the current year and 10.5% next year. Moreover, its EPS is expected to grow at a rate of 14.5% per annum over the next five years.

GOOGL’s revenue and EPS have grown at a CAGR of 18% and 20%, respectively, over the past 3 years. The CAGR of the company’s free cash flow has been 7.6%.

Analysts expect GOOGL’s revenue to increase 15.3% in the current quarter, 10.5% in the current year, and 21.3% next year. The company’s EPS is expected to grow 2.2% in the current quarter, 5.5% in the current year, and 18% next year. Additionally, GOOGL’s EPS is expected to grow at a rate of 16.5% per annum over the next five years.

GOOGL has an edge over MSFT here as well.

Profitability

GOOGL’s trailing-12-month revenue is 1.16 times MSFT’s. However, MSFT is more profitable, with a net profit margin of 32.3% versus GOOGL’s 20.8%.

MSFT’s ROE and ROA of 41.4% and 12.1% compare favorably with GOOGL’s 17.5% and 7.7%, respectively.

Valuation

In terms of forward P/E, GOOGL is currently trading at 35.55x, 11.2% more expensive than MSFT, which is currently trading at 31.98x. However, MSFT is more expensive in terms of trailing-12-month P/S (11.15x versus 7.22x). Also, its forward PEG of 2.48x is 10.2% higher than GOOGL’s 2.25x.

In terms of trailing-12-month price/cash flow, MSFT’s 24.67x is 14.5% more expensive than GOOGL’s 21.54x.

So, GOOGL looks much more affordable compared to MSFT.

POWR Ratings

While GOOGL is rated “Strong Buy” in our proprietary POWR Ratings system, MSFT is rated “Buy.” Here are how the four components of overall POWR Rating are graded for MSFT and GOOGL:

MSFT has an “A” for Trade Grade and Industry Rank and a “B” for Buy & Hold Grade and Peer Grade. In the 96-stock Software – Application industry, it is ranked #25.

GOOGL has an “A” for Trade Grade, Buy & Hold Grade and Industry Rank, and a “B” for Peer Grade. It is ranked #2 in the 59-stock Internet industry.

The Winner

While both MSFT and GOOGL are good long-term investments considering the world’s increasing reliance on technology, GOOGL appears to be a better buy based on its market dominance and superior pace of expansion.

GOOGL has grown to this position by dominating internet search, an area where MSFT has tried but failed to equal GOOGL. GOOGL’s search engine has made it the largest player in the internet ad space, an area where it remains by far the market leader. However, GOOGL remains largely an ad company, as a significant portion its total revenues are contributed by Google Advertising. The steady return ad sales activity to the pre-pandemic levels is a trend that is working in favor of GOOGL.

Though users are largely dependent on cloud services in the new, remote communications culture, GOOGL is working to catch both MSFT and Amazon (AMZN) in the cloud computing segment. GOOGL is currently in third place by market share in the cloud computing segment. Moreover, Google X’s diverse bets, which range from Waymo (driverless cars) to Verily and Calico (life sciences) to Deepmind (Artificial intelligence systems), also present immense growth potential for the company. Hence, we believe GOOGL is likely to outperform MSFT, if not near-term then certainly in the long run.

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MSFT shares were trading at $212.75 per share on Thursday morning, up $0.95 (+0.45%). Year-to-date, MSFT has gained 36.34%, versus a 15.65% rise in the benchmark S&P 500 index during the same period.

About the Author: Sidharath Gupta

Sidharath’s passion for the markets and his love of words guided him to becoming a financial journalist. He began his career as an Equity Analyst, researching stocks and preparing in-depth research reports. Sidharath is currently pursuing the CFA program to deepen his knowledge of financial anlaysis and investment strategies. More...