The cloud is one of the major growth areas in technology today. Two tech companies in particular dominate the market for cloud services—Amazon.com Inc. (AMZN, Financial) and Microsoft Corp. (MSFT, Financial). Both companies have richly rewarded shareholders over the past several years as their soaring stock prices reflect the broad move toward cloud storage.
Going forward, investors considering Amazon or Microsoft should note the key differences between the two, both in terms of their business models as well as their capital allocation strategies. Amazon continues to plow virtually all of its cash flow back into the business, meaning investors waiting for a dividend are likely to be disappointed.
While Amazon could be the better growth stock moving forward, investors looking for a mix of growth and dividend payments should pick Microsoft.
Business overview and recent events
Neither Amazon nor Microsoft started out in the cloud business, but both have gravitated there in recent years due to the explosive growth of the cloud services market. Both companies are diversified across many other segments. Amazon is the e-commerce giant of the world, with a market capitalization of $863 billion. The company's online retail business fueled its explosive growth in recent years, and its cloud service provider—known as Amazon Web Services—will fuel its future growth for years to come.
Due to the capital-intensive nature of its core e-commerce segment, Amazon has never paid a dividend. But the company’s profitability has increased substantially thanks, in large part, to AWS. For example, the AWS segment generated operating income of $2.177 billion in the most recent quarter, representing approximately 57% of Amazon’s total operating income for the quarter. This is despite the fact the core retail operation continues to dwarf AWS in terms of revenue.
The ongoing need for reinvestment in the retail business, as well as Amazon’s new growth initiatives such as media content and potentially health care, means the company is not likely to pay a dividend for the foreseeable future.
Meanwhile, Microsoft has also grown by leaps and bounds in the cloud market, while maintaining other equally profitable businesses. The company develops, manufactures and sells both software and hardware to businesses and consumers. Its core offerings include the Windows operating system, Office business software, software development tools, video games and gaming hardware under the Xbox brand and, of course, cloud services.
With a market capitalization of $890 billion, Microsoft is similar to Amazon in size. But to date, the company is far more profitable. It reported second-quarter 2019 earnings results on Jan. 30. The company generated revenue of $32.5 billion, growing 12.4% from the prior-year quarter. Microsoft grew across its segments, with productivity and business process revenues rising 13% year over year to $10.1 billion, while Office Commercial sales rose 11% year over year. The largest growth driver was, once again, Microsoft’s cloud segment, with Intelligent Cloud revenues rising 21% year over year to $9.4 billion.
Azure, Microsoft’s high-growth cloud platform, grew by another 76% year over year, showcasing the company's strong position in this ever-growing market. The company generated earnings per share of $1.10 during the second quarter, which beat the analyst consensus and represents a growth rate of 15% from the year-ago quarter.
Microsoft’s significantly higher margins allow the company to return cash to shareholders through share repurchases as well as dividends. In contrast, Amazon does not pay a dividend since it continues to generate razor-thin margins in the core retail business.
Growth, income or a mix of both
There is little doubt that Amazon has been the better growth stock to this point. In 2008, the company generated $14.84 billion in revenue. Ten years later, sales climbed to $233 billion, an incredible level of growth over the past decade. But until recently, Amazon’s impressive sales growth had not translated to meaningful earnings per share growth as the company struggled to earn a profit. This has changed dramatically due to the explosive growth of AWS, but Amazon still does not generate enough earnings to justify paying a meaningful dividend to shareholders.
On the other hand, Microsoft has not generated the same kind of top-line growth as Amazon in recent years, though it certainly is no slouch for its part. But it has been more of a mix of growth and income for shareholders. Microsoft is a Dividend Achiever, having raised its dividend each year for over 10 years in a row, including a solid 9.5% increase last September.
Both companies have generated huge returns for shareholders over the past decade. Amazon generated annualized total returns of 38%, while Microsoft had total annual returns of 23%. Amazon outperformed Microsoft over the past decade, but its outperformance may not last over the next 10 years, particularly if a recession occurs. Microsoft’s lower stock valuation and dividend yield provide valuable margins of safety during a market downturn. While growth investors still have plenty of reasons to stick with Amazon, income and value investors should pick Microsoft when it comes to cloud tech stocks.
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