It's 2023, and the days of meme stock investing and "mooning" asset valuations should be behind us. It's safe to say that the last 12 months were not kind to technology stocks, and many on Wall Street believe that this year may be no different. While inflation is beginning to cool down, it still hovers at levels that are forcing corporations of all sizes to operate with lean teams and tight budgets.
Three of the largest companies by market capitalization, namely Microsoft (MSFT 2.11%), Amazon (AMZN 3.45%), and Alphabet (GOOG 10.01%) (GOOGL 10.31%), all have signaled that challenging times are ahead. All three of these tech behemoths have consumer businesses as well as large enterprise software segments.
Despite the cloudy near-term outlook, there are several tailwinds and catalysts that long-term investors should be encouraged by. As equities continue to decline, it may be close to an opportune time to buy up some shares in these three companies.
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Is it time to panic yet?
All three tech leaders have given investors some reason to get nervous. Just this week, investors learned that Microsoft is planning to lay off 10,000 employees, or roughly 5% of its workforce. Additionally, Amazon announced in late 2022 that it was also planning layoffs. During times of uncertainty, it is crucial for investors to zoom out and look at the bigger picture.
In the case of Microsoft, CEO Satya Nadella has repeatedly referenced a slowdown in consumer spending, which has directly impacted the company's personal computing and hardware devices business. While inflation is starting to fall, it likely remains at a high-enough rate such that consumers are questioning each and every purchase they make.
Despite the near-term headwinds Microsoft will continue to face in its consumer business, management has done a solid job of keeping the company nimble and very well may have just unlocked its next growth engine. Over the last several weeks, artificial intelligence tool ChatGPT seems to have taken over the internet. Microsoft took note, and rumors are swirling that the tech giant is mulling a multibillion-dollar investment in ChatGPT's parent company, OpenAI, and plans to integrate the technology into its search tools as well as cloud applications.
Amazon's situation is a bit different from Microsoft's. During the peak of the COVID-19 pandemic, Amazon's core e-commerce business certainly benefited from an influx of more pronounced consumer purchasing. As a result of the heightened demand, Amazon went on a hiring spree. Amazon's total head count increased from 1.3 million for the quarter ended Dec. 31, 2020, to 1.6 million by Dec. 31, 2021.
While the company's Q4 2022 results are yet to be released, Amazon's headcount was slightly over 1.5 million at the end of Q3 2022. It is pretty clear that Amazon got ahead of itself and overhired. Now, the company is scaling back and looking to tighten its operating expenses.
In the case of Alphabet, two of the biggest challenges the company has battled over the last year or so is the rise in popularity of short-form video application TikTok, as well as Microsoft's and Amazon's dominance in the cloud computing space. Regarding TikTok, Alphabet has rolled out its own competing version of the app called YouTube Shorts. However, given the consistent decline in advertising revenue from YouTube over the last several quarters, it is clear that Alphabet has some work to do.
Like Microsoft, Alphabet's leadership may have identified a new catalyst, as YouTube will now be the home of the National Football League's Sunday Ticket broadcast in a multiyear deal valued at nearly $14 billion. This type of action is clearly a response by Alphabet's management to acquire users on YouTube.
In addition to YouTube, Alphabet is also much smaller than Amazon and Microsoft when it comes to cloud computing. Moreover, Alphabet's cloud platform is still very much in growth mode; therefore, it's operating at a net loss. However, the silver lining is that Alphabet is catching up and gaining market share. The company's cloud segment is growing much faster than Amazon's, which should signal some encouragement from investors.
Cash is king
For all three companies, one thing is certainly clear: Cash is king. While layoffs are unfortunate and even uncomfortable for those affected, shareholders should realize that the respective management teams are executing these drastic measures as part of corporate governance. In other words, give the current volatility in the macroeconomic environment, these companies are taking control of expense profiles and doing what is necessary to reduce costs.
Despite unknown revenue growth in the short term, investors can see that each of these companies still carry healthy balance sheets. As of Sept. 30, 2022, Amazon held $35 billion of cash and equivalents on its balance sheet, Microsoft held $23 billion, and Alphabet held $22 billion. Although consumer spending has had a net negative impact on all three businesses, investors can see that none of these tech leaders will be facing a liquidity crunch anytime soon.
Keep an eye on valuation
At the time of this writing, Microsoft carries a market capitalization of $1.8 trillion and trades at 26 times its trailing-12-month earnings, and Alphabet carries a market capitalization of $1.2 trillion and trades at 18 times its trailing-12-month earnings. The long-run average of the S&P 500 is around 15 to 16 times price-to-earnings.
Despite the rich valuations over the broader market, it is hard not to be excited about the future prospects of each company. Layoffs should contribute to a net increase in cash flow at Microsoft. And the company is also working on new products and services, specifically in artificial intelligence and quantum computing, that could lead to strong long-term growth.
Meanwhile, Alphabet is doing what it can to combat new competition in the advertising arena. Moreover, its cloud computing segment remains an exciting part of the business as it catches up to Amazon and Microsoft.
Interestingly, Amazon's market capitalization is the lowest compared to its cohorts and hovers right around $1 trillion. However, given the dramatic fluctuations in its earnings, particularly due to the ebbs and flows of e-commerce, Amazon's price-to-earnings ratio is a less useful measure of valuation. The company's price-to-sales ratio is 2 times, roughly half of what it was a year ago.
Economists around the globe continue to debate whether a recession is already baked into the stock market. Long-term investors are better off not trying to time the market and pinpoint the perfect moment to buy. Rather, data shows that Microsoft and Alphabet are both valued higher than the broader market in the long term.
However, given the muted near-term prospects of each company, it is likely that both stocks are close to a bottom at this point. Moreover, Amazon could actually end up benefiting from a recession, as consumers may flock back to its cost-friendly e-commerce business. For this reason, Amazon stock may also be close to a bottom, and its 2023 results may end up surprising investors.
For those with a long-term outlook, it is likely that each of these companies are approaching buys, and it could soon be an opportune time to lower your cost basis.
