How Much Bigger Can the Tech Giants Grow?

Markets Motley Fool

In this segment of the Motley Fool Money podcast, host Chris Hill, Million Dollar Portfolio's Jason Moser and Matt Argersinger, and Motley Fool Pro and Options' Jeff Fischer break down the stories of Amazon.com (NASDAQ: AMZN), Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), and Microsoft (NASDAQ: MSFT), and they continue to be page-turners.

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For Amazon, revenue last quarter was up 34%, retail sales were up 22% year over year, AWS revenue was up 42%, and its high-margin segments are growing by leaps and bounds. How much longer can the e-commerce leader keep up this pace? And how big are its opportunities in areas like the online pharmacy business? Meanwhile, Alphabet is growing across the board, and at an accelerating rate; and thanks to Google's skinny TV bundles and YouTube streaming, people are spending a lot more time watching its video content -- but yes, there was a minor smudge in this shiny report, related to its mobile penetration. And as for Microsoft, it's continuing to use the cloud to power its renaissance. But if you think that means that its PC-related business has to be declining, think again. (These Fools give a lot of credit to the man at the top, CEO Satya Nadella.) So here's the real question: All of these stocks have just set new highs. Which, if any, are still solid buys at these levels?

A full transcript follows the video.

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This video was recorded on Oct. 27, 2017.

Chris Hill: We begin this week with Earningspalooza. Three of the biggest public companies all hitting record highs. Microsoft, Alphabet, we're going to start with Amazon's third-quarter report. Revenue came in just shy of $44 billion, that's a 34% increase over a year ago. Shares of Amazon on Friday, Jeff, up 12%.

Jeff Fischer: Unbelievable, Chris. The shares are up 46% year to date, and 360% just in the last five years. If you thought you were too late to Amazon, you were not. The good news is, I don't think you're too late now, either. I think the company will be much more valuable five and 10 years from now. Right now, it has a $525 billion market cap. Let's see where it is five years from now, I bet it'll be much higher. Anyway, Chris, retail sale sales were up 22% year over year. That's higher than they grew a year ago, when they grew 20%. That's amazing. Amazon Web Services revenue was up 42%, which is a little slower than a year ago, but still very strong. The company did have lower operating margins pretty much across the board. The Web Services business, which is key, which is where a lot of profits are made, the operating margins were up at sequentially, so people were happy to see that, as well. Not talked about so much, but really interesting to me is, ad revenue was up about 60%. Huge growth there, and that's very high marching revenue, and they have a lot more room to keep growing that revenue.

Hill: Yeah. Amazon, a company that famously keeps things close to the vest, they don't have an advertising division, per say, Matty. The number he referenced there goes in their "other revenue" segment.

Matt Argersinger: It speaks to the tremendous optionality of this business. I'll go back to the core retail business growing over 20%. If you look at the overall e-commerce just in the U.S., it's growing in the low teens year over year. So, as mature as Amazon is, it's still putting up this amazing growth. We've talked a lot about other companies making headway. Wal-Mart is making headway, Target, to a certain extent, other e-commerce players. But Amazon, the Juggernaut of the business, is still growing and accelerating its growth, which I just think is exceptional.

Fischer: Yeah, Matt, and they haven't yet cracked groceries to a great extent. They bought Whole Foods, but it's still a small part of their business. They haven't really cracked healthcare, let alone pharmacy, there are rumors that they're looking at how to get into that, because that's a giant industry. So, there's a lot more for them to grab.

Hill: As we came into the studio to tape today, there were all these reports that CVS is in talks to buy health insurer Aetna for as much as $66 billion, and part of the rationale for that, if it in fact goes through, is so that CVS can defend against Amazon.

Argersinger: It's amazing. Actually, Jason was telling me before the show that you can type AmazonRx, and right now it goes just Amazon. But clearly, whatever anecdotal evidence you need, Amazon is getting into this business. I think about the fact that, now, my wife and I, for the most part, we get all of our groceries at home. Amazonfresh is an amazing service. With the Whole Foods acquisition, you have more and more to choose from. But I like the idea of, you go see your doctor, order directly from your doctor online through Amazon, and by the time you get home, your drugs are waiting for you, along with your groceries.

Hill: Do you think there's someone whose job it is at Amazon to just secure URLs? That Jeff Bezos is like, "I don't know if we're going to do this, go ahead and secure that just in case." Alphabet's third quarter profits came in higher than expected, so did overall revenue. Their margins are growing. Matty, did anything bad happen to Alphabet? Or was this all sunshine and rainbows? Because it really looks like all sunshine and rainbows.

Argersinger: It really is. There might be one thing I'll mention. This is another example of the big getting bigger, the big getting stronger. We talked about Amazon's business accelerating. Alphabet's business is kind of accelerating. Revenue up 24%. That's above the average they've been generating the last several years. Growth in the core advertising business was up 21%, and growth in Google's other revenue -- this is not other bets, just other revenue, hardware, cloud -- that business was up 40%. What really impresses me, and it's impressed me for a long time but continues to blow my mind is YouTube, and the power of what that's doing for the platform and for Google's search business. 1.5 billion users spending an average of 60 minutes per day on YouTube. It's massive. But one interesting thing the company pointed out in the conference call is, they're also racking up a lot of time in the living room. 100 million viewing hours per day at home through smart TV or other TV devices. No longer is YouTube just, I'm looking at my phone or my iPad or playing a game or something like that. It's now, people are watching YouTube on their TV and doing so at really prodigious rates.

Jason Moser: Yeah, the skinny bundle offering, just like Hulu has, I think there's a lot of runway there. And we're seeing them making a big advertising push. Certainly, we've seen some stuff here going on in the baseball playoffs season. I think that, as time goes on, those skinny bundles that Hulu and Google are offering are only going to get better, because they give consumers what they want in the way of content, and the service aspect of it is just so much more optimal. When you consider that you don't have to call anybody, you just go in there and click the button here or there, you record a payment, you don't have to call or wait on hold --

Argersinger: It's so easy.

Moser: The service aspect of it is so much better than something you might deal with with Verizon or Comcast, who notoriously have very bad reputations for service.

Argersinger: One small cloud over this sunshine and rainbows we've been talking about is the traffic acquisition cost. They're up 54% year over year. That's of course, Google paying smartphone makers and web browsers to run Google search and ads. Critical cost, that's again up 54%. Mainly that's because mobile is so much more of an expensive platform for them, they have to really pay up for it. We want to see that scale out, we want to see that number come down, otherwise Alphabet's operating profits probably are going to keep up with revenue over time.

Hill: Microsoft's first-quarter profits came in solidly higher than Wall Street was expecting. Jason, the cloud business continues to grow, has been growing for a while. The PC business growing this quarter, too. That was a little bit surprising.

Moser: A little bit. The word I used back in July was cloud. The word this quarter is cloud. This is the same old thing here, but that's in a good way. When you look at the commercial cloud business, the run rate is now at $20 billion annually. For context, Amazon Web Service is around $18 billion, both leaving Google in the dust in that regard right now. But, Google is obviously a very good player as well. The more I think about it, the more I think Satya Nadella is Microsoft's Steve Easterbrook. We think about all of the success that Easterbrook has had at McDonald's in turning this business around. Satya Nadella has done a lot of the same with Microsoft, identifying the key opportunities, cloud. I think we probably all still have some questions about the LinkedIn acquisition, but the bottom line is, they're realizing stronger engagement and it's contributing to earnings per share. Then, there's a big runway in gaming, as well. A new Xbox coming soon. All in all, this is still a business that's extremely relevant in offices all over the world. Again, I think that's going to continue, and Nadella and his team are doing a very good job exploiting that and monetizing it, and investors are clearly winning.

Hill: We've got Alphabet, Amazon, Microsoft. We have three stocks. These are three of the four biggest public companies out there. Apple is the biggest. We'll be talking about them on next week's show when they report their earnings. But of these three stocks, for investors who are looking over the next five to 10 years, they're all hitting new highs this week. Are any of them unreasonably priced? Is one more so than the others, you look at and think, "Even if you have the five to 10 year time horizon, it's something where you want to wait for a little bit of a pullback?" What do you think, Matty?

Argersinger: I'll call it Microsoft only because I think the business, compared to the other two, is a lot more mature, and the valuation for Microsoft is kind of in line with Alphabet. And I think Alphabet has a lot bigger runway ahead of it. What Microsoft has done has been very impressive. But if I had to pick one of the three, I would say Microsoft.

Hill: Jason?

Moser: I think Amazon is the easy target there, but Matty hits on a very good point. We have to think forward. Microsoft, I think we've been conditioned to accept this low valuation. It's still somewhere around 20X free cash flow. But, on a forward-looking basis, I think Alphabet and Amazon are the companies that have the bigger opportunities. Honestly, I think you buy a little bit of all three and you'd be just fine.

Hill: Jeff?

Fischer: I'll say, there's no question that all three trade at a bull market type of price, and at some point in the next five to 10 years, we'll see a significant market drawback. It's almost inevitable. Call it a bear market, whatever you like. We'll see a year or two of stocks falling, at least, in the next five to 10 years. That said, I think all three are priced such that five years, there's a decent chance they'll generate a decent return over five years. 10 years, there's a very good chance they'll generate a good return. That is, as long as Amazon or Google, Alphabet, is not attacked by regulations, or Amazon, which trades at 75X free cash flow, compared to Microsoft at 20X, doesn't make some missteps and hit its profitability prospects.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Chris Hill owns shares of Amazon. Jason Moser owns shares of Apple. Jeff Fischer owns shares of Alphabet (C shares), Amazon, and Apple. Matthew Argersinger owns shares of Alphabet (C shares), Amazon, and Apple and has the following options: short December 2017 $900 puts on Amazon. The Motley Fool owns shares of and recommends Alphabet (A and C shares), Amazon, Apple, and Verizon Communications. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.