Tech giants must validate $2 trillion valuation

The five biggest U.S. technology companies have shown they can dominate a massive market. Investors are waiting to see if they can replicate that success.

Apple, Alphabet, Microsoft, Facebook and Amazon.com are worth a combined $2.2 trillion, and are five of the 10 most valuable businesses in the S&P 500. That’s a big bet on staying power.

With their core markets maturing, the tech leaders will provide critical updates on the status of new businesses in their first-quarter earnings reports.

Amazon has made the most headway establishing a second act with its Amazon Web Services division, which is on pace to generate $10 billion in annual revenue. With a far higher profit margin than its e-commerce business, Amazon has attracted a whole new class of investors that view the company as a computing pioneer.

But Microsoft and Google are investing heavily in their own clouds and competing with AWS for the rapid shift in dollars from traditional data centers to the cloud.

Microsoft’s challenge is proving it can expand without sacrificing the fat margins it captures in its legacy Windows business. Meanwhile, practically all of Google’s revenue comes from online advertising, and the search leader has to show it can build and sell services to large corporations.

“One of the broadest trends in technology today is this massive shift to cloud computing — towards small business, medium-size and large-size enterprises moving more and more of their processes, their workloads and their databases up into the cloud,” said Mark Mahaney, an internet analyst at RBC Capital Markets. “The company that’s most driving that and most benefiting from that has been and we think will continue to be Amazon.”

Tech’s first quarter

Company Market cap Annual sales Earnings date
Apple $609 bln $231 bln Apr. 25
Alphabet $530 bln $74 bln Apr. 21
Microsoft $440 bln $93 bln Apr. 21
Facebook $312 bln $18 bln Apr. 27
Amazon.com $295 bln $107 bln Apr. 28

Mahaney has buy recommendations on Amazon and Alphabet, and doesn’t cover Microsoft. Amazon shares have dropped 7.4 percent this year, after more than doubling in 2015, while Alphabet has gained 0.3 percent to start the year, as of Friday’s close.

Apple has gained 4.36 percent, after falling 3 percent in 2015. With two-thirds of its revenue coming from iPhones and with analysts expecting a decline in sales of its flagship devices, Apple is out to prove it can expand in software and services.

Credit Suisse analyst Kulbinder Garcha wrote in a recent report that subscriptions for iTunes, iCloud and eventually a TV service should be substantial enough to drive the stock, because investors will appreciate the profitability of software and the recurring monthly revenue.

Apple is far from a one-hit wonder, of course. The company still generates more than $20 billion a year in Mac sales and revived itself 15 years ago with the iPod music player. But software has always been an afterthought.

“The growing iPhone installed base could enable Apple to grow its higher-margin services business through additional iTunes, apps and software sales as well as through services such as Apple Pay and Apple streaming music service,” Canaccord Genuity analyst Michael Walkley wrote in an April 13 report. Services present “long-term opportunities to drive further top-line growth.”

Facebook is by far the fastest-growing among the big tech companies, and analysts are projecting 43 percent expansion in 2016. The stock has climbed at least 34 percent each of the past three years and is up 4.8 percent this year.

Investors want to see what the world’s most valuable social network is going to do with its big-ticket purchases. Instagram is now showing ads, Oculus VR headsets are just starting to ship to consumers and WhatsApp, which Facebook bought for $19 billion two years ago, is a free and ad-free service. Facebook has also been adding features to its homegrown messaging service, including chatbots that allow businesses to automate customer support.

While Facebook’s ad business is a rapidly growing cash cow, the company’s $312 billion market capitalization suggests shareholders are wagering on the company’s ability to make money elsewhere.

“We see Facebook’s revenue growth visibility being enhanced by Instragam this year, Messenger in 2017 and more mass market VR/AR and maybe WhatsApp by 2018,” Rosenblatt Securities analyst Martin Pyykkonen wrote in an April 12 report. He rates the stock a buy.

Here are revenue and profit estimates for each of the big five:

Alphabet

Google’s parent is scheduled to announce earnings after the bell on Thursday, and analysts are projecting 18 percent revenue growth to $20.3 billion, according to Thomson Reuters. Earnings per share probably increased 22 percent to $6.33. Alphabet’s “other bets,” which include all the businesses separated from core Google, likely more than doubled but still accounted for just $176 million in revenue, according to Wedbush analyst James Dix.

Microsoft

Microsoft is also slated to report after the market closes on Thursday. For the fiscal third quarter, analysts are expecting sales growth of 1.7 percent to $22.1 billion, according to Thomson Reuters, with EPS rising to 64 cents from 61 cents. The intelligent cloud business, which includes Microsoft’s Azure cloud infrastructure service, probably reached $6.3 billion, according to analysts surveyed by FactSet.

Apple

Declining revenue and profit is expected at the iPhone maker on April 25, with fiscal second-quarter sales dropping 10 percent to $52.1 billion, and EPS falling 14 percent to $2, according to a Thomson Reuters survey of analysts. IPhone sales likely slumped 18 percent to $33.1 billion, according to FactSet. Canaccord Genuity’s Walkley estimates a 27 percent increase in services revenue to $6.4 billion.

Facebook

CEO Mark Zuckerberg will update investors on April 27, and analysts expect sales growth of 48 percent to $5.3 billion with EPS more than doubling to 41 cents, according to Thomson Reuters. Mobile advertising accounted for about 78 percent of first-quarter revenue, according to FactSet.

Amazon

After the close of trading on April 28, the e-retailer is expected to report sales growth of 23 percent to $28 billion, according to a Thomson Reuters survey, with EPS of 58 cents following a 12-cent loss a year earlier. AWS revenue likely jumped 61 percent to $2.5 billion, according to FactSet.

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