MSFT and FB Both Jumped After Earnings: Which is the Better Buy?

On Monday, I wrote in these pages that although manufacturing and consumer staples had been the recent trendy picks among analysts and traders, tech could be the sector that impressed the most during this earnings season. So far, that has proved to be right, and the emerging trend towards tech success was confirmed yesterday, when Facebook (FB) and Microsoft (MSFT) reported. Both tech giants knocked it out of the park.

Microsoft’s success was clear-cut when they released earnings after the bell. They increased revenue year over year by over fourteen percent to an expectation beating $30.6 billion and generated EPS of $1.14, easily beating the forecast of $1.00. In that context, the only surprise about the five percent jump in the stock in this morning’s pre-market trading is that it isn’t even higher.

Facebook’s success was not quite as obvious. At first glance, their numbers looked disappointing, but after excluding one-time charges the EPS of $1.89 would have beaten the consensus estimate for $1.62. Solid increases in user numbers and advertising revenue also help explain why the stock, after an initial dip on the gross number, jumped higher last night.

 

The successes outlined make both stocks a buy, but if forced to choose between them, the immediate case for one is more compelling than the other.

As good as Facebook’s performance last quarter was, there is a cloud hanging over them. The one-time charge that made such a difference to how the results were perceived was for $3 billion, in expectation of a fine by the FTC relating to privacy violations.

Two things should be clearly understood here.

First, Facebook has around $23 billion of cash on hand. $3 billion will make a dent in that but will not affect performance in the future. Second, the growth last quarter shows that investors’ biggest fears about the privacy issues are unfounded: they are neither deterring the public nor advertisers from availing themselves of Facebook’s services.

The fact that users have effectively given their opinion of the privacy scandals, however, will probably not deter regulators. If they are to justify a fine in the billions, they have to show a harm to the public, and if that is the case, they are duty bound to legislate to prevent that happening again.

In other words, regulation of Facebook’s business is a virtual certainty.

Mark Zuckerberg is certainly saying the right things about that. On the analysts’ call yesterday, he said “I understand that any regulation may hurt our business, but I think it is necessary.” He even went so far as to suggest that a better regulated environment would offer long-term benefits as user trust increases.

 

He may well be right, but for the stock market, “regulation” is a boogey man. It is quite possible that the FTC or Congress will come up with rules that protect consumers yet still allow Facebook to prosper, but for the stock that isn’t the point. The actual performance of the company means that FB can continue higher from here, but just the presence of that word will probably limit gains for a while.

Microsoft, on the other hand, faces no such limitations. 

Once again, the most impressive thing about their earnings report was the way the good numbers were achieved. They continued to show good growth in the enterprise and cloud businesses, but positive news from personal computing and even search advertising was much more of a surprise. When the now CEO, Satya Nadella was appointed just over five years ago, I made the point that his background in the enterprise and cloud division was a positive, but also that his relative failure with Bing would probably be a lesson well learned. It seems now that it was.

Despite that, MSFT still has a forward P/E of around 25. That would be appropriate were the company still viewed as they were five years ago, as more of a mature manufacturing company than a vibrant tech concern, but Nadella has changed all that. Back in 2014, I wrote that the fact that MSFT dropped on news of Nadella’s appointment showed that the market was underestimating him, and a so-so forward P/E at this point, despite his huge successes, shows that they still are.

Both Microsoft and Facebook released earnings yesterday that proved that well-managed companies that produce something that people want succeed, regardless of what the chattering classes may say about them. That is a welcome reminder for all investors of where their focus should be, but perceptions do matter, and the perception that Facebook will soon face regulatory issues may hold that stock back. That makes MSFT the better bet for now.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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