2 Big Tech Stocks to Buy
Plus, more takeaways from earnings season so far.
Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar’s chief U.S. market strategist Dave Sekera to discuss one thing on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. But this week, we’re breaking format. We’re going to spend a little time talking about some of Dave’s key takeaways from earnings season so far, and then, Dave will be talking with one of Morningstar’s analysts about a few high-profile tech companies he covers.
Dave, good to see you. Let’s get right into things. On last week’s show, you talked about shifting your focus from the earnings and forecasts of tech companies to some real economy companies. What are your takeaways from that group so far?
Dave Sekera: I just talked to our industrials’ analyst, and he had a really interesting comment, and that was that he thinks right now reality is actually better than perception. So, I think what he’s hearing in a lot of these conference calls that the earnings are pretty good and, again, we expected them to be. A lot of these management teams already guided down or gave pretty conservative guidance at the beginning of the year. So, the earnings have been pretty easy to meet or beat. But the guidance going forward, I think a lot of it is showing that, yes, people are still seeing the economy starting to slow, but it’s not slowing at a faster rate.
He then broke it down into what he calls the long-cycle versus the short-cycle industrials. So, the long cycles—those being the ones that have kind of the longest time period between when you start manufacturing a product to when it’s actually sold—have been holding up very well. So, I think you would expect that at this point of the economic cycle. But what he did note was those short-cycle companies, again, where there is a short time period between when the product is made and sold, that’s where he is starting to see the most weakness. And I think that also then agrees with our economic view that we’re looking for a relatively stagnant quarter here in the second quarter and then potentially a contraction in the economy in the third quarter.
Dziubinski: Let’s talk a little bit about some of the earnings and forecasts that have been coming out of Big Oil.
Sekera: Again, Big Oil has really been hitting it on all cylinders this past quarter. Oil prices have come down a little bit, but they’re still relatively high, same with natural gas prices. When we look at some of their other divisions like the refining and some of their end products, those are all very strong margins at this point in time as well. And even the cost-savings programs that they’ve been implementing over the past couple of years really seem to be giving a lot of savings there and really helping out as well. So, again, record earnings across the Big Oil companies, lots and lots of cash flow. So, again, easily able to support the large dividends that they’re paying as well as some really big share buyback programs.
Now, having said that, I would caution investors most of these stocks right now are pretty fully valued at this point, and a lot of that just is based on our longer-term outlook for oil prices. So, again, oil prices should probably remain relatively higher here in the short term. OPEC has been cutting production. But over the long term, when we think about where the supply/demand curve meets marginal oil costs in the future, we still expect that WTI, West Texas Intermediate, prices will come down in the long term down to $55 a barrel from where they are today.
Dziubinski: Now for something completely different. Dave is going to talk to one of our analysts about a couple of Big Tech stocks.
Sekera: Thanks, Susan. So, today I’m going to be speaking with Ali Mogharabi, senior equity analyst at Morningstar Research Services on our media and telecom team. Now Ali and I are going to be discussing his outlook on Alphabet GOOGL and Meta Platforms META.
Hi, Ali. Now, Alphabet is currently rated 4 stars, and we assign the company with a wide economic moat. Now, Alphabet fell almost 40% last year, and thus far this year, the stock has rallied approximately 20%. Now, can you just briefly walk us through why you think the market sold off so much last year and what’s changed the market’s mind this year?
Ali Mogharabi: Well, thanks, Dave. So, for one, the hawkish monetary policies led to the compression of tech companies’ valuation multiples as you know. Of course, that has also been assumed to lead to an economic downturn, which negatively affects ad spending, which of course impacts Google’s revenue growth. And add to that the aggressive strategy on YouTube Shorts, which wasn’t monetized and actually impacted YouTube revenue further. The third thing was the emergence of OpenAI’s ChatGPT in November and how Microsoft MSFT was actually planning to use it with Bing, which we now have seen, and whether that was an online search disruption and also whether Google could maintain its dominance. So, all of those three actually drove the stock down.
Now, this year, the market is taking into account that the company is focusing more on cost efficiency, slowing down growth in headcount, reducing its real estate footprint, and just operating much more efficiently. All of that, of course, helps the bottom line. And then, on the top line, cloud continues to perform well, which, by the way, was also profitable for the first time. The company has also demonstrated that, one, on the AI side, it has the artificial intelligence technology. I mean, OpenAI’s GPT is actually based on the AI neural network or architecture, an open-source one, created by Google in 2017. They have a variety of large language models or LLMs that can actually be utilized to battle ChatGPT or Bing’s chatbot. Two, while their demo didn’t go well, I think the market became a bit relieved that yes, Google does have its own generative AI-driven search. It’s called Bard. And so, with that assumption, it would not necessarily lose its market leadership, and that thought is actually now discounted a lot more. And then, three, just prioritizing AI, combining deep mind with the brain could actually give them leverage in terms of not just having those intangible assets on the AI side, but also all of them working together focused on successfully developing and commercializing what looks like the next generation of online search. So, all of those helped the stock recover a little bit this year, and then, of course, you also have their Q1 numbers.
Sekera: Out of curiosity, what were your main takeaways from the first-quarter earnings?
Mogharabi: The positives were that the search advertising business returned to growth. Strength in cloud continued and actually generated operating income, as I mentioned earlier, and that was for the first time. We saw consolidated margin expansion for the first time in three quarters, and of course, they had another authorized share buyback. But there were other things that still did create uncertainties. They had included YouTube Shorts still pressuring YouTube ad revenue, the macro environment, I should say, pushing their network revenue down, and of course, AI, which is pushing the firm to keep investing in computing capabilities.
Sekera: And then, just lastly, I would like to know when you model out the long-term cash flows that Alphabet is going to generate, what’s your main underlying assumptions that really drive your valuation for this company?
Mogharabi: I’m expecting to focus on cost efficiency to bear fruit. And when you combine that with the return of top-line growth to low teens, mainly because of increase in ad spending as the macro uncertainty is lessened a little bit, then you’re looking at operating leverage and margin expansion. On the top line, I’ve modeled a 10.5% five-year CAGR, and in terms of margins, I’ve assumed average margin of almost 24% through 2027, and that’s up from my 22% assumption for this year. And then, capex will probably go up this year, and then, I’m assuming that it’s going to be actually stabilizing at this level or maybe slightly below that through 2027, given of course the further investments they have in AI.
Sekera: Well, just to wrap things up here for investors, with where the stock is trading today, what would you be thinking or recommending for investors that are interested in Alphabet?
Mogharabi: Alphabet remains a wide moat, and with recovery in advertising, continuing growth in cloud, followed by profitability in that segment, we think it is attractive, and of course, that’s certainly demonstrated by the discount to our fair value estimate that it’s trading at right now.
Sekera: Let’s move on to Meta Platforms. Now, Meta Platforms actually fell 64% last year, and now it’s actually almost doubled year to date. So, over this time period, in your mind, what really changed that could impact the intrinsic value of the firm over that time period?
Mogharabi: This is a pretty good and actually an interesting story, as always with this name, with Meta. A few things have actually driven the rebound. First, while TikTok is certainly one of Meta’s largest and most fierce competitors, we think that Meta can also benefit from the short-form vertical video that TikTok actually brought into this social-media space. It helps create more advertising options for the advertisers. We’re not assuming that Meta is actually going to be the number-one player on that front, nor are we assuming that TikTok is going to completely displace Meta. Simply, we feel comfortable that Meta will get its piece of that growing pie, even if it’s not the biggest piece, and I think the market has begun thinking the same way.
As you remember, Meta was confronted with new and innovative formatted content before. It was not the first mover when it came to stories, which was introduced by Snap. But in 2017, Meta started rolling out its stories and actually started monetizing them pretty effectively after a couple of years. So, obviously, it has done pretty well on that front. We think TikTok is a more formidable competitor than Snap was. But again, we believe while it’s not the biggest piece, Meta is going to get its fair piece of that growing pie with reels, which it actually began monetizing late last year.
The second reason behind the rebound we think from the beginning, we didn’t think Apple’s AAPL policies would actually impact the effectiveness of ads on Meta’s platform, given that Meta has a significant amount of first-party data and, of course, the amount of time users spend on that platform is pretty high and has remained pretty high. Apple’s policies impacted the measurement of the ads’ effectiveness more than anything else, which made actually advertisers a little bit hesitant. And we thought that overtime Meta and advertisers could actually make the necessary changes after which advertisers’ confidence would come back, resulting in ad buying on the platform that, based on the Q1 results, it actually showed that it is happening, it is taking place.
And then, third, with user growth plus engagement levels remaining high, Meta’s platforms are likely to keep attracting ad dollars. Even with the emergence of new competition, we haven’t seen significant or consistent decline in its daily or monthly user count, and engagement has remained pretty stable.
And then, of course, some geopolitical factors have helped actually the stock recover. One is that the lawmakers are considering banning TikTok. Actually, Montana state lawmakers passed legislation recently doing exactly that. Even if that doesn’t happen at the federal level, the uncertainty is probably going to drive content creators to focus a little bit more on distributing and monetizing their content on non-TikTok apps like Instagram’s Reels, YouTube Shorts, or Snap’s Spotlight. So, these have all helped the stock recover recently. And then, the last thing I want to mention is that such a threat that TikTok represents to Meta, I think FTC’s antitrust case against Meta could actually weaken. So, the market may be taking that into account, too.
Sekera: Looking forward from here, what do you think investors should be focused on that’s going to drive more continued growth of its economic value?
Mogharabi: Simply, the drivers include mainly the return of ad spending and more effective monetization of Reels, ad conversion and its measurability improvement, margin potential and an unharmed network effect. All of those I think are going to contribute to the top- and bottom-line growth for Meta this year and going forward. Now, we did increase our fair value estimate on Meta by $18 per share to $278. That was only a 7% increase in fair value estimate, but what led to that increase was the better-than-expected results on the top and bottom line in the first quarter, which I think in the case that Meta’s full-year results are also going to be better, especially with much better operating expenses than we had modeled.
Sekera: Great. Well, thank you. Just to wrap things up, so following the rally in Meta that it has experience year to date, what would you recommend to investors today?
Mogharabi: Well, following the huge rally, as you mentioned, we think it’s still an attractive stock. It’s still a 4-star. It’s still trading at an over 16% discount to our fair value estimate. So, it remains attractive. And remember, Meta has actually a lot of intangible assets, whether it’s data and/or technology whereabouts. So, we do think that it can continue to remain innovative and continue to come up with new products in order to attract users and/or increase their engagements consistently over time.
Sekera: All right. Well, thank you very much for your time and for your insight, Ali. I appreciate it. And with that, Susan, I would like to turn it back over to you.
Dziubinski: So, viewers, we’d like to hear from you. What stocks would you like Dave to talk about with Morningstar’s analysts? Drop your requests in the comments section below and be sure to join Dave and I live on YouTube every Monday morning at 9 a.m. Eastern, 8 a.m. Central. And while you’re at it, subscribe to Morningstar’s channel. Have a great week.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.