Earnings season is here, and Big Tech is showing some much-wanted signs of positivity. Microsoft (MSFT -0.18%) and Alphabet (GOOG 1.06%) (GOOGL 1.08%) both reported first-quarter results, and investors seemed pleased. Each company experienced heavy buying activity following the reports, along with Wall Street analysts flurrying to revise price targets.
The common denominator in each report was that cloud computing remains a strong, resilient business despite lingering fears of economic slowdown. Let's unpack the earnings results and analyze whether these stocks belong in your portfolio.
Is Big Tech recession-proof?
"Recession-proof" businesses generally sell items deemed necessary for daily life. For example, stocks of consumer staples companies that sell food or cleaning supplies could be considered good investments during otherwise cloudy economic times. By contrast, companies selling luxury items and services, like clothes or travel, may not perform as well during economic contractions.
While Microsoft and Alphabet do not necessarily sell luxury goods, both firms sell expensive software and hardware. For several months, executives have been warning investors about lengthy sales cycles and tighter corporate budgets. Subsequently, even the largest blue chip companies have been issuing questionable guidance for a while now.
Q1 at a glance
For the quarter ended March 31, Microsoft reported $52.9 billion in total revenue, up 7% year over year (or 10% on a constant currency basis). The darling of the earnings report was Microsoft's cloud computing segment, Azure.
The company's Intelligent Cloud business grew 16% annually (19% constant currency) to $22.1 billion in revenue. This growth was driven by server products and cloud services -- namely, Azure and other cloud services grew 27% year over year (31% constant currency). This level of growth is nothing short of impressive during such a challenging period.
Alphabet reported total revenue of $69.8 billion for the quarter ended March 31. This represented 3% year-over-year growth (6% constant currency). Although this level of growth may come across as a bit mundane, investors should not overlook it. Revenue from Google Cloud came in at $7.5 billion, or 28% year-over-year growth.
If that wasn't enough to excite you, check this out: In 2021 and 2022, Google Cloud lost $3.1 billion and $2.9 billion, respectively. So even though this segment was growing from a revenue perspective, it was unprofitable for Alphabet. But this quarter? Google Cloud reported its first-ever profit, coming in at $191 million or about a 3% operating margin. For reference, Amazon's cloud platform, Amazon Web Services (AWS), has historically generated around a 30% operating margin. Investors should be encouraged by Alphabet's results and the long-term opportunity for expanded cloud margins.
Image source: Getty Images.
What does Wall Street think?
Per usual, following the earnings releases, equity research analysts published revised price targets for Microsoft and Alphabet.
Regarding Microsoft, some of the more notable revisions came from Bank of America, RBC Capital, Piper Sandler, Citigroup, and Credit Suisse. Each institution has a "buy" or "buy equivalent" rating on the stock and sees 10% to 15% upside from current trading levels. When it comes to Alphabet, TD Cowen, Raymond James, and Oppenheimer, all have a "buy" or "buy equivalent" rating on the stock and see 20% to 30% upside from current trading levels.
The underlying theme here is that Wall Street sees massive upside in both stocks. It should be noted that Microsoft currently trades at around a 30 times price-to-earnings (P/E) ratio, while Alphabet trades at 23 times P/E. Thinking about this another way, the long-run average of the S&P 500 is 15 to 16 times P/E.
Despite several months of warning signs, Microsoft and Alphabet just proved how much customers rely on each company's infrastructure. Even in the face of high inflation and fears of recession, these tech behemoths are hard to bet against.
While Alphabet and Microsoft are very much mature blue chip companies, each contains an underlying growth story. One way to think about Azure and Google Cloud could be to see them as start-ups within the larger organization.
The current premium on each stock likely does not yet price in the full potential of the cloud segments, especially given how nascent artificial intelligence's role is at the moment. For this reason, it's tough to argue against forming a long-term position and capitalizing on this buying opportunity.
It is easy to get distracted by long-run averages and traditional fundamentals. So while it appears that Alphabet and Microsoft may be trading above intrinsic value, perhaps take the approach that each stock is just expensive relative to the broader market.
