Big Tech’s Got Issues, Sure. But Is It Over?

Big Tech’s Got Issues, Sure. But Is It Over?
Paul Allison, CFA

over 1 year ago6 mins

  • Third-quarter earnings shed some light on investors’ key worries, and in some cases heightened them. How these companies perform on these metrics in the quarters to come will be crucial.

  • For Amazon and Microsoft, how much further their cloud businesses slow is top of investors’ minds. Both firms will need to rein in spending if growth rates continue to slow.

  • Apple is in rude health, so it's just a case of keeping up the good work. Meta’s issues feel almost existential: it could come down to whether you have faith in the metaverse or not.

Third-quarter earnings shed some light on investors’ key worries, and in some cases heightened them. How these companies perform on these metrics in the quarters to come will be crucial.

For Amazon and Microsoft, how much further their cloud businesses slow is top of investors’ minds. Both firms will need to rein in spending if growth rates continue to slow.

Apple is in rude health, so it's just a case of keeping up the good work. Meta’s issues feel almost existential: it could come down to whether you have faith in the metaverse or not.

Mentioned in story

Big Tech isn’t the gravy train it used to be. The sector’s giants are each grappling with their own challenges, and increasingly, investors are deciding they don’t want to climb aboard. So, let’s take a look at Amazon, Alphabet, Apple, Microsoft, and Meta, what they’re up against, and what investors are on the lookout for…

1. Amazon

Is it time for management to spend less?

Amazon (AMZN) might be starting to feel its age. Cardboard box deliveries were never likely to maintain their lockdown-era levels, but after the latest earnings update, investors are now worried that the firm’s higher-octane profit engine – Amazon Web Services (AWS) – is entering a more mature (i.e. slower growth) phase. And this all comes at a time when management has been loosening the purse strings. Take a look at the chart below, which shows Amazon’s free cash flow (which is money left over after everyday expenses and large outlays). Notice that after some bumper years, it’s fallen off a cliff.

Amazon annual free cash flow. Source: Koyfin.
Amazon annual free cash flow. Source: Koyfin.

What will investors be looking for?

With growth companies like Amazon, investors might be prepared to overlook profit in favor of sales growth, provided there’s a promise of future bounty. And over the past few years, helped by rapid growth from its highly profitable AWS business, Amazon’s been on a path of impressive growth and improving profitability. But, the firm's aggressive spending has thrown a wrench into the works and the stock’s fallen more than 40% this year. For that drop to be an opportunity, though, you’d have to believe that Amazon will pull back on spending while maintaining a decent level of growth. And right now a lot of investors seem less than convinced that’ll happen.

2. Alphabet

Is it cyclical or something else?

Alphabet (GOOG/GOOGL) has some businesses with bright futures. The firm's cloud platform – while a distant third behind AWS and Microsoft’s Azure – is growing rapidly. Google’s parent is also at the forefront of the next wave of technologies like artificial intelligence (AI). But because cloud makes up less than 10% of the firm’s sales and AI might be years away, it's advertising that matters most today. And until recently, those ad dollars have been rolling in. Take a look at the chart below. Even in the depths of the Covid outbreak ad revenues fell just 8%, and they surged after the world emerged from lockdowns. But the last two quarters have gotten investors worried. Alphabet bosses pin the slowdown on a weaker economy, and they also – rightly – point out that last year’s monster growth rates make for very tough comparisons. But let’s face it, the ad market’s mature, and a lot of dollars have already shifted to the digital channel. All that means the pace of Alphabet’s future growth is in doubt.

Source: Alphabet.
Source: Alphabet.

What will investors be looking for?

The chart below shows that Alphabet’s stock price-to-earnings (P/E) ratio is close to all-time lows, which suggests that investors aren’t hopeful Alphabet can get its ad growth groove back any time soon. Right now, then, risks to Alphabet’s near-term and long-term growth are dominating the mood, but if ad spending picks up next year and the firm’s cloud business keeps ticking along, Alphabet’s fortunes could start looking rosy once again. Sentiment, after all, can be a fickle thing.

Alphabet’s P/E ratio. Source: Koyfin.
Alphabet’s P/E ratio. Source: Koyfin.

3. Apple

What does sustainable growth look like?

Eventually, Apple (AAPL) will run out of people to sell iPhones to, so it’s important to think about what happens then. Mind you, Apple’s products will probably still grow for some time. After all, the brand has loyal fans who’ll cough up for the latest gadgets, and there are plenty of untapped customers in places like India. Even so, it’s unlikely that Apple will continue to motor along at the same pace as the last ten years. Where growth settles depends on a couple of other things too. Firstly, will the firm’s services business – 20% of current sales – continue to enjoy faster-than-overall-company growth? And secondly, will Apple be a player in tomorrow’s tech frontiers, like AI?

What will investors be looking for?

You can fully expect Apple’s long-term sales growth to slow, but whether that’s to say 2%-4% or 6%-8% will be crucial. Apple's stock price valuation has climbed over the past few years, which raises the expectations bar somewhat. So a slowdown toward the lower end of those ranges would probably not be warmly welcomed.

4. Meta Platforms

Will the metaverse only ever be virtual?

Facebook’s parent (META) nailed its colors to the metaverse mast with a name change a year ago, and despite a 70% fall in its share price since, CEO Mark Zuckerberg seems as confident as ever. And he’s putting his money (well, shareholders’ money) where his mouth is. The firm announced a big spending increase as it doubles down on the metaverse and battles rival TikTok on the social platform front. But Meta is unlikely to turn its virtual future into actual dollars anytime soon and this has raised a huge question over the firm’s direction.

What will investors be looking for?

Meta’s caught between the devil and the deep blue sea. Shareholders probably wouldn’t be happy if Meta turned a blind eye to competition, accepted that core platforms Instagram and Facebook are maturing, and managed the business accordingly. But that’s probably a better option than putting all your eggs in one basket and that’s why investors are voting with their feet. But Zuckerberg changed the world before. So if you’re a disciple or you believe that Facebook and Insta have a longer shelf life than people believe, then Meta’s stock, now at an all-time low valuation, is a seductive if not highly risky potential opportunity.

5. Microsoft

Can Microsoft’s cloud keep up its sky-high growth?

Microsoft’s (MSFT) cloud business now accounts for more than 50% of the firm's overall revenues, and it’s been motoring along. Throw in a pandemic-driven PC boom and the software giant’s sales have notched close to 20% growth for the past couple of years – the fastest pace in 20 years. But with laptop and desktop sales now hitting the skids, Microsoft’s cloud business needs to maintain a growth rate somewhere close to last quarter’s 20% level if the overall company is to maintain its run of impressive sales growth.

What will investors be looking for?

Cloud-hosting business Azure – a major part of the firm’s cloud segment – did post a slower-than-expected growth of 35% last quarter and this has Microsoft fans shifting nervously in their seats. At today’s price, the shares trade around 23x P/E, which is back to levels last seen in 2017. This suggests that investors don’t expect the growth rates of the past few years to continue. If Azure growth slows meaningfully from here, investors will likely ratchet those expectations lower still, and that wouldn’t be good for the share price. But if Azure maintains something like last quarter’s growth rate, that would probably reverse some of the negativity that surrounds the stock at the moment.

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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