When investing in technology stocks, safety isn’t always in the numbers.
Take Google Inc. and Microsoft Corp., both of which reported results last week. Both are giants but Google appears to be riskier than Microsoft because it trades for a considerably higher price-to-earnings ratio.
But let’s take another look at this comparison.
As an investor, I’m interested in how cloud computing and the migration toward mobile operating systems drives changes in each company’s business. I see Google as the innovator with the most to gain, and Microsoft as the responder with the most to lose.
Both have well-defined areas of strength. Google is the No. 1 player in online search, video and advertising, while also taking the No. 1 position in mobile operating systems (Android). Microsoft is the No. 1 player in PC operating systems (Windows) and enterprise productivity software (Office).
The important point to note is that most of Google’s strengths are in areas that are growing rapidly. Microsoft’s muscle lies in markets that are plateauing.
To be sure, Microsoft is still impressively robust. It just posted a very healthy set of numbers, essentially meeting Street expectations. Its normalized revenue for the whole business was up 8 per cent over last year. Its Windows division posted flat revenue, which isn’t bad considering research firm IDC says the PC market declined by more than 10 per cent in the latest quarter.
The profit outlook for the software giant appears solid. According to S&P Capital IQ, analysts believe Microsoft will earn $2.78 (U.S.) in earnings per share (EPS) this year, followed by $3.09 and $3.33 in the coming years.
The stock sure isn’t expensive, at about $31 a share. The P/E ratio on 2015 earnings is 9.3, if you believe analyst estimates, and the annual dividend is a healthy 3 per cent.
How does that compare with Google’s results? Revenue at the search giant was up 21 per cent from a year earlier, excluding the acquisition of Motorola Mobility.
The vast majority of Google’s revenue comes from advertising, and Google keeps people viewing its ads by dominating the market in all of the ways people use their computing devices. It dominates in search. It dominates in video (YouTube). It dominates in mobile (Android), and in Web e-mail (Gmail).
Google has a highly profitable business model and earnings are expected to grow. S&P Capital IQ shows that analysts expect Google to earn over $46 in EPS this year, growing to over $62 in 2015.
If you go strictly by the numbers, Google is more expensive than Microsoft. It trades at 12.6 times 2015 estimates compared with Microsoft, at 9.3 times.
But think about what’s happening in this market over the long term. Tablets, smartphones and other mobile devices are showing much faster growth than traditional PCs, which, if anything, appear to be in decline. Cloud computing and data storage are becoming more important than locally stored apps or data.
The Web browser is already more important than the operating system. The services offered through that Web browser are more important than built-in applications for most consumers. In short, Google is already winning in all of the areas where Microsoft is playing catch up.
Would I rather pay a few extra points on the P/E ratio to ride the winner? Heck, yeah.
While I suspect the future for Google’s revenue growth largely comes from advertising, it seems to me the vehicles for delivering this growth will continue to diversify. Just listen to what Larry Page, Google’s CEO and co-founder, says on public conference calls.
Instead of dwelling on his company’s gigantic advertising business, he would rather talk about the products and services that will feed growth to Google’s bottom line for years to come – Android, for instance, or Google Chromebook computers, or Google Glass, a wearable computing device the company is developing.
Speaking of Chromebook, I recently bought one to replace an old Mac we kept near the kitchen. A few years ago I would have replaced the Mac with a cheap Windows PC. But today? I bought a $269 Samsung Chromebook at Best Buy. It boots up in under 10 seconds and connects to all the Web services we need. I predict products like this will further accelerate the decline of Microsoft Windows.
As an investor with a long-term focus, I realize Microsoft is in fine shape for now. But over the next decade, I feel confident that Google is a much safer stock than the company Bill Gates built.