Alphabet, Microsoft Remain Cash-Rich, Secular Growth Powerhouses

Image Source: Shawn Carpenter

By Brian Nelson, CFA

All eyes were on Alphabet (GOOG) (GOOGL) and Microsoft (MSFT) after the bell January 30. We include both Alphabet and Microsoft in the newsletter portfolios due to their tremendous cash-based sources of intrinsic value: net cash on the balance sheet and free cash flow generation. It would take a monumental shift in the trajectory of these fantastic businesses for us to ever consider removing them from the newsletter portfolios, and we’re reiterating our favorable long-term view on both following their respective calendar fourth-quarter reports.

Let’s first start with Alphabet. Revenue advanced ~13% on a year-over-year basis in the fourth quarter, while the company’s operating margin expanded ~3 percentage points, to 27%. Net income was up ~52%, while diluted earnings per share advanced more than 56% in the period. Google Search performed well and so did YouTube ads, but the Street was looking for a bit more in these areas. Google Cloud surprised a bit to the upside, and the company continues to streamline its cost structure with headcount reductions and office space optimization.

When it comes to cash-based sources of intrinsic value, Alphabet is one of the best. The company ended 2023 with ~$141.9 billion in total cash and marketable securities, against a long-term debt balance of just ~$13.25 billion, good for ~$128.7 billion in net cash, which is about as good as it gets. Cash flow from operations advanced to ~$101.7 billion in 2023, while capital spending nudged higher to ~$32.25 billion, resulting in free cash flow of ~$69.5 billion, up from ~$60 billion in 2022. Both cash flow from operations and capital spending moved in the wrong direction in the fourth quarter, but one data point a trend doesn’t make.

We’re sticking with Alphabet as a top weighting in the Best Ideas Newsletter portfolio, despite growing concerns about how artificial intelligence [AI] may disrupt Google Search in the long run. Google’s search algorithm provides a list of the most relevant searches upon request, but AI-driven processes offer a much cleaner alternative with perhaps less room for advertising. It remains to be seen how AI may disrupt Google’s bread and butter advertising business, but Alphabet does have AI capabilities of its own, and any exposure to Alphabet likely should also include exposure to Microsoft, which for now is the leader in monetizing AI across its business model.

Microsoft’s calendar fourth-quarter results were excellent, in our view. The company beat on both the top and bottom lines, and these weren’t easy hurdles. Revenue advanced an incredible 18% (16% in constant currency) in the quarter, while operating income jumped an even more impressive 25% on a non-GAAP basis (up 23% in constant currency). Microsoft Cloud revenue increased 24% (up 22% in constant currency). Both net income and diluted earnings per share jumped 26% on a non-GAAP basis (up 23% in constant currency), showcasing that even at its size, Microsoft is able to scale costs to drive material operating leverage.

It’s important to reiterate that, as you’re reading these growth rates, Microsoft is already a behemoth so the pace of expansion in the quarter was nothing short of amazing. Microsoft ended 2023 with total cash and short-term investments of $81 billion and short- and long-term debt of $74.2 billion, as it has moved more toward a net-neutral balance sheet (given its large deal for Activision), but nonetheless it held a net cash position at the end of the year. For the three months ended December 31, cash flow from operations expanded an incredible 68.7%, to ~$18.85 billion, while free cash flow in the period leapt to ~$9.2 billion, up from ~$4.9 billion in the year-ago quarter.

Commentary from both Alphabet and Microsoft was positive on AI, with Alphabet noting that its divisions are benefiting from its AI investments, with CEO Sundar Pichai noting that “the best is yet to come.” Microsoft’s commentary was perhaps even more positive, with CEO Satya Nadella saying that it has “moved from talking about AI to applying AI at scale.” As noted before, there are concerns growing about the potential for AI to disrupt Google Search in the long run, but if investors hold both Alphabet and Microsoft, as in the Best Ideas Newsletter portfolio, it’s likely that any share shifts in search advertising due to AI may accrue in part to Microsoft Bing. Both Alphabet and Microsoft remain net-cash-rich, free-cash-flow generating, secular growth powerhouses, and we remain fans.