Breaking down earnings at Meta Platforms and Alphabet

1) Two of my three favorite tech stocks, Meta Platforms (META) and Alphabet (GOOGL), reported quarterly earnings this week... and the market had vastly different reactions.

So today, as I've done in previous quarters, I'll take a look at each company's report and share my latest thoughts...

Let's cover Meta first, which dropped a staggering 10.6% yesterday after reporting first-quarter earnings on Wednesday after the market close (you can see the press release here and presentation slides here).

It was a strong quarter:

• Users (which Meta calls "family daily active people") rose 7% year over year to a mind-boggling 3.24 billion – more than 40% of all humans on Earth.
• Revenue jumped 27% year over year to $36.5 billion, slightly above expectations.
• Expenses only rose 6% year over year, leading to a huge increase in operating margin from 25% to 38% and causing operating income to soar 91%.
• Meta's tax rate dropped from 22% to 13% year over year.
• As a result, profits and free cash flow ("FCF") rose 117% and 81% year over year, respectively.

So why did the stock pull back so hard yesterday?

In part, this happened because Meta has been on an absolute tear – more than quadrupling in the past roughly 18 months since I pounded the table on it when it traded below $100 per share in a six-part series beginning on November 1, 2022.

This year, going into earnings, the stock was up 39% – making it the sixth-best performer in the S&P 500 Index.

With such a run like that, disappointment on any front in the earnings report was bound to set off investor panic...

And that's what happened with Meta's revenue outlook for the second quarter: 18% year-over-year growth, which was well below that of the first quarter.

Investors are also concerned about rapidly rising capital expenditures ("capex"), which are driven by heavy investments in artificial intelligence ("AI").

This new "Heard on the Street" column from the Wall Street Journal has the story: Meta's License to Spend on AI Gets Checked. Excerpt:

That blank check investors wrote to Mark Zuckerberg seems to top out around $40 billion.

That is the new upper end of this year's projected capital expenditures by Meta Platforms. The parent company of Facebook and Instagram raised its capex range for the year by 12% as part of its first-quarter report late Wednesday, with the chief executive citing the need to boost investments in generative artificial intelligence. It is a big number that is nearly double what the company has averaged over the past five years and nearly on par with projected spending this year by Microsoft (MSFT) and Google-parent Alphabet, two much larger companies by annual revenue.

There's an AI arms race going on among Meta, Alphabet, and Microsoft – as you can see in this chart from another WSJ article, which shows the rapidly rising capex for the latter two:

Investors are concerned that Meta, the smallest of the three companies, will either get left behind or see its profits significantly diminished as it tries to keep up.

My view on the stock is that, if I owned it, I would be very comfortable continuing to hold it. I long ago said Meta is one of the greatest businesses of all time... and that view hasn't changed.

If it was trading at 40 times or 50 times earnings, I would be worried. But at yesterday's closing price of just below $442 per share and consensus earnings-per-share ("EPS") expectations of $19.97 this year and $23.25 next year, it's trading at 22.1 times this year's earnings and 19 times next year's earnings.

That's a very modest multiple for such an incredible business.

If I didn't own it, would I buy it today? That's a tougher question...

Probably not, even though I think it's likely to outperform the market over the next five years. As a value investor, I much prefer to buy stocks that are really beaten down, as Meta was 18 months ago...

2) Turning to Alphabet...

GOOGL shares soared have soared about 10% today – on track for the best post-earnings reaction in more than five years – after the company reported strong first-quarter earnings:

• Revenue rose 15% year over year to $80.5 billion – well above expectations and driven by ad growth on YouTube rising 21% year over year.
• Expenses only rose 5% year over year, leading to a nice increase in operating margin from 25% to 32%, the highest in nearly three years, and operating income to jump 46% year over year.
• Profits jumped 57% year over year and, thanks to share repurchases reducing the diluted share count by 2.3%, EPS were up an even stronger 62% year over year.
• Operating cash flow rose 23% year over year to $28.8 billion, but capex nearly doubled from $6.3 to $12.0 billion... so FCF actually fell 2.2% to $16.8 billion.
• The company announced it would begin paying dividends for the first time (albeit only $0.80 per year, equal to 0.5%) and increased its share-repurchase authorization by $70 billion.

I'm a bit surprised that Alphabet's shares are up so much, given that CEO Sundar Pichai didn't give much information about how AI is affecting Alphabet's core Google search business.

Here's a WSJ article with more on this: Google Sales Accelerate as Ad, Cloud Businesses Hold Up Amid Costly AI Push. Excerpt:

Investors are closely watching for signs of whether and how the tech giants are reaping new business from investments in AI programs that can generate text and images. Google, in particular, has faced persistent questions about its ability to defend its business model, which relies heavily on search ads, as more people turn to chatbots for answers.

Google has offered few specifics about how AI is affecting its sales and profits. Multiple analysts asked Pichai on a call Thursday for more details on how AI is improving Google's financials.

Pichai said Thursday the company is encouraged by an increase in search usage among people trying its new AI tools, but he otherwise provided little in the way of metrics on the technology's business impact.

Both Meta and Alphabet are investing heavily in AI. But at least in Meta's case, any advances are likely to help its business, whereas they threaten Google's...

That said, I also long ago identified Alphabet as one of the world's greatest businesses – and it still is.

With consensus EPS expectations of $6.83 this year and $7.87 next year, the stock, currently around $170 per share, is trading at 24.9 times this year's earnings and 21.6 times next year's earnings. That's a bit higher than Meta, but still a reasonable multiple for such an incredible business.

So, like Meta, Alphabet looks like a very comfortable hold at these levels.

Forced to choose between them, right now I would lean toward Meta because the stock is a bit cheaper, it's growing faster, and is less threatened by AI.

On a final note, I'll mention that I first recommended Meta and Alphabet as long-term core holdings to readers of my former newsletter Empire Investment Report in our inaugural issue on April 17, 2019, back at my old firm Empire Financial Research.

Since then, through yesterday's close, Meta and Alphabet are up 147% and 152%, respectively – both well above the 74% return for the S&P 500.

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.