It's hard to find two companies to compare head-to-head that match the size and scale of Amazon.com (AMZN -1.65%) and Microsoft (MSFT -2.45%). The e-commerce giant has a market cap of $475 billion, and Microsoft's value comes in at a staggering $546 billion.
The two companies have taken different paths to success, and investors wondering which one has more room for growth should consider three key angles: competitive advantage, financial position, and valuation.
Image source: Getty Images.
Competitive advantage
Let's start with Microsoft. The software giant has one of the most enduring competitive advantages with its Office Suite and its Windows operating system, both of which run on millions computers worldwide. Even as Apple has grown PC sales (and, by association, its operating-system market share), it still pales in comparison with Microsoft's PC software advantage.
Microsoft has also expanded into more hardware offerings, which could eventually strengthen its software moat even further, and it has built out strong services such as its Azure cloud hosting. In the end, though, it's the company's software that's still king, and there's no likely threat to its throne anytime soon.
Amazon's competitive advantages, meanwhile, come from the size of its e-commerce platform and its ability to get people to sign up for its Prime membership -- which keeps people locked into its ecosystem.
Prime membership offers not only fast shipping and discounted prices on some items, but also free services such as music and video streaming. It's estimated that Amazon has 80 million Prime members in the U.S., and these subscribers spend nearly twice as much on Amazon each year than non-Prime members do.
Amazon's combination of e-commerce scale, pricing, distribution, and the corresponding network effect for Prime members means the company has locked in its advantage for years to come.
Winner = Amazon.
Financial position
Of course, having a competitive advantage is only one part of the investing equation. The next is whether a company has the financial strength to stay on its feet for the foreseeable future.
Here's how Microsoft and Amazon stack up:
| Company | Cash | Debt | Net income | Free cash flow |
|---|---|---|---|---|
| Amazon | $21.5 billion | $21.6 billion | $2.5 billion | $16.8 billion |
| Microsoft | $121.5 billion | $86 billion | $17.8 billion | $36.9 billion |
Data source: Yahoo! Finance.
Both companies are in solid financial shape. Microsoft has more debt than Amazon, but the company's total cash reserves and its strong net income and free cash flow are more than enough to balance out those debts.
While Amazon is doing well, too, Microsoft's ability to generate strong free cash flow and amass large amounts of cash -- albeit mostly overseas -- means the software giant gets the win for this category.
Winner = Microsoft.
Valuation
Last, but certainly not least, we come to valuations. Let's keep this simple by looking at each company's current price-to-earnings ratio, its forward P/E, which looks at future earnings projections; and the enterprise value-to-EBITDA ratio (that's earnings before interest, taxes, depreciation, and amortization).
| Company | P/E Ratio | Forward P/E | EV/EBITDA |
|---|---|---|---|
| Amazon | 188.9 | 87.9 | 39.42 |
| Microsoft | 31.2 | 21.3 | 17.62 |
Data sources: Yahoo! Finance and The Wall Street Journal.
It's a little difficult to compare these two companies perfectly on these metrics, because Amazon is still growing rapidly, hence its high P/E ratios, while Microsoft is more of a slow-and-steady investment right now, hence its low P/E ratios and conservative EV/EBITDA.
For investors who are looking for high growth and don't mind paying a relative premium for it, then Amazon is the way to go. But for investors looking for a much more conservative play, Microsoft's stability is likely to be appealing. Because these are two completely different investing strategies, I think this comparison is a draw.
Winner = Tie.
The verdict: well, it depends
I'm going to have to say that this match-up is too close to call. The problem (or benefit, depending how you look at it) is that each company has a strong competitive advantage in its market, both are financially strong, and both appeal to different types of investors at the same time.
Those looking for slow and steady might prefer Microsoft's business (and it's 2.25% dividend yield), while Amazon makes more sense for investors willing to take on the risks of growth and the volatility that comes with it.
