Over the past five years, Facebook (FB) stock has gained an impressive 684.66%, while Microsoft (MSFT) is up by a much smaller 205.47% in the same period. In the past 12 months, however, the tables have turned, with Microsoft outperforming Facebook by a considerable margin: Microsoft is up by 45.3% versus a 29.2% return for Facebook.
Statistical evidence shows that quantitative factors such as financial quality, valuation, fundamental momentum, and relative strength can be effective return drivers for stocks over the long term. With that in mind, let’s take a look at Facebook and Microsoft from a quantitative perspective in order to find out which one is a better purchase for investors going forward.
Leaving all the unnecessary complexities aside, a stock is simply a share in an ownership of a business. All else the same, shares in companies with superior growth rates and above average profitability tend to generate higher returns for investors.
Both Facebook and Microsoft are among the strongest companies in the S&P 500 index when looking at a multiplicity of financial quality indicators, but Facebook is one step ahead of Microsoft in terms of growth rates and profitability.
Microsoft is benefitting from accelerating revenue growth in recent years thanks to booming performance from Azure, Office 365, and LinkedIn. However, Wall Street analysts are still expecting Facebook to outgrow Microsoft going forward. Analysts are expecting an annual revenue growth rate of 26.59% for Facebook and 10.22% for Microsoft over the coming five years.
The two companies are also exceptionally profitable, but Facebook is superior to Microsoft when it comes to profit margins. The operating profit margin for Facebook is 50.12% of revenue, while Microsoft retains 29.26% of sales as operating profit.
The following chart summarizes key financial quality indicators for Facebook and Microsoft. Looking at revenue growth in the past five years, revenue growth on a trailing 12-month basis, expected revenue growth, expected earnings growth, operating margin, and return on assets, Facebook beats Microsoft across all of the indicators considered.
Looking at valuation ratios such as enterprise value to EBITDA and forward price to earnings, valuation levels are fairly similar. However, since Facebook has a higher expected growth rate, the price to earnings growth - PEG - ratio is considerably lower for the social network. Facebook also has a more convenient valuation in terms of the price to free cash flow ratio.
On the other hand, for investors who appreciate cash distributions via dividends and buybacks, Microsoft is the way to go. The dividend yield is not particularly high at 1.66%, but Facebook pays no dividends at all.
Besides, Microsoft has substantially increased its dividends while also reducing the share count through buybacks over the past several years. When it comes to cash distributions, payments trajectory can be as important as the size of those distributions, and Microsoft has the financial strength to continue rewarding investors with growing dividends and buybacks in the years ahead.
Looking at the fundamentals in isolation doesn't tell the whole story behind a stock, since the fundamentals in comparison to expectations can have a huge impact on stock prices. In other words, when the company is delivering better than expected earnings and expectations about future earnings are increasing, this can be a powerful upside fuel for the stock.
Both Facebook and Microsoft announced better than expected earnings last quarter, and the two companies are benefitting from increasing earnings expectations going forward. Facebook has a more volatile trajectory in terms of earnings expectations, but the magnitude of the increase in earnings expectations is higher for Facebook in comparison to Microsoft.
Business momentum is a tailwind for both companies, but a stronger one for Facebook.
Money has an opportunity cost, when you buy a stock with mediocre returns, that capital is not available for investing in companies with superior potential. Besides, winners tend to keep on winning in the stock market, so you want to invest in stocks that are not only doing well but also doing better than other alternatives.
The two tech giants are outperforming the S&P 500 year to date, but Microsoft is doing considerably better than Facebook over the period. When it comes to relative strength, Microsoft is the clear winner.
Putting It All Together
The PowerFactors system is a quantitative investing system available to members in my research service, "The Data Driven Investor." This system basically ranks companies in a particular universe according to the factors analyzed in this article for Facebook and Microsoft: quality, valuation, momentum, and relative strength.
The system has produced solid backtested performance over the long term. The chart below shows how the 50 stocks with the highest PowerFactors ranking in the S&P 500 index performed in comparison to the SPDR S&P 500 ETF since 1999. The backtesting assumes an equal-weighted portfolio, monthly rebalanced, and with an annual expense ratio of 1% to account for trading expenses.
The system has materially outperformed the benchmark, with annual returns of 13.01% per year versus an annual return of 6.2% for the ETF in the same period. In other words, a $100,000 investment in the SPDR S&P 500 in January of 1999 would currently be worth around $321,900, and the same amount of capital allocated to the quantitative portfolio would have a much larger value of $1.07 million.
Looking at the aggregate PowerFactors score, Facebook is in the best 10% of companies in the S&P 500, while Microsoft is in the top 20%. The two companies look well positioned for attractive returns going forward. However, given the choice between Facebook and Microsoft, Facebook looks like the best alternative from a quantitative perspective.
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Disclosure: I am/we are long FB.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.