But this is a narrative-breaking result. So Microsoft, for most of this year, has been cast aside as losing in AI because AI is so good that it's going to ruin the software business, and then AI is so bad that they're wasting money investing in data centers. And what they just reported will break both of those narratives. They're the adult in the room. If the returns are there, they'll invest. And that's why I expect there to be a big sigh of relief across the AI trade, because if Microsoft is setting the tone as opposed to less responsible actors like Mr. Zuckerberg or, to some extent, Google, then maybe we're in better hands than we thought we are.
Welcome to Prof Markets. I'm Edson. It is July 30th. Let's check in on yesterday's market vitals. The major indices fell sharply as President Trump vowed to resume strikes on Iran. He told Fox News, quote, "We're going to beat the out of them." Brent crude rose back above $90 per barrel. Meanwhile, the Federal Reserve held interest rates steady, sending stocks even lower. More on that later. And finally, Treasury yields surged.
Okay, what else is happening? Two of the largest companies in tech reported earnings yesterday, but investors only rewarded one of them. Meta grew revenue 28%, slightly beating expectations, but its profits fell 13% because costs jumped 55%. Its operating margin dropped from 43 to 31%, and the company's sales forecast came in under analyst expectations. The stock fell as much as 11% in after-hours trading.
Microsoft, on the other hand, had great news. Revenue was up 18% year-over-year. Profits grew 32%. Azure, its cloud business, accelerated to 43% growth, which was faster than last quarter and faster than analysts expected. The stock popped as much as 7% after the bell.
What the two have in common is spending. Both are building AI infrastructure at record scale, and neither show any signs of slowing down. But investors seem to be more frightened than excited. Microsoft stock is down nearly 20% this year. Meta's is down 10%. This raises an important question: How much longer will investors fund this buildout? Here's Alba's answer. We're speaking with Gil Luria, head of technology research at D.A. Davidson. Gil, good to see you. We'll start with Meta and then we'll get to Microsoft. Investors not happy with these Meta results, at least in after-hours. We'll see how it moves throughout the day. What did you make of that earnings report?
It was barely passable. So they beat by just a little bit, and they guided below expectations for next quarter. As you pointed out, they're growing expenses faster than revenue. They're growing capex faster than revenue. They increased their capex guidance by just a little bit, which was a little relief, but overall it's not an impressive result. And more importantly, Mr. Zuckerberg had a whole hour to explain how he's going to monetize the massive AI investments, and he didn't really give us a firm answer. He basically said, "We'll figure it out as we go." And that's just not good enough right now, not with how nervous investors are about this investment. And he just left investors wanting more. That's why you're seeing this disappointment.
That was going to be my main question: has he laid out a plan for how he will actually generate a return on these incredible AI infrastructure investments, which continue to rise? I mean, as you say, he raised the capex by a little bit, but he still raised the capex. Is there anything — I mean, do we have any understanding? There was the rumor, for example, that Meta would start a cloud business. That was the reporting we heard. Do we not know at all?
We know what the pieces are, and he confirmed that that is one of the pieces they have on the board. So one is, hey, we sell a lot more ads for a lot more money. They've been doing that recently. Let's not forget — let's be kind to Meta for a second. They just grew 28%. That's almost twice as fast as Google. They're massive share gainers in the advertising market. That's the part investors would love to own. It's all the other stuff that they're less comfortable with. But what he said is, okay, we do that, right? Then we do have this opportunity to sell compute to others. We have opportunity to sell enterprise products now. But really what we want to do is be selling compute to consumers. We think we have the biggest opportunity in selling personal assistants to consumers. We think we're going to be better at that than anybody. How those pieces rank — there were a lot of questions on the call, and he wasn't clear about priorities or timing on any of that — but those are the pieces, and they intend to monetize in any of those pieces while continuing to invest. He was asked the question directly: why are you still investing while you turn around and sell capacity? And he said, well, we're selling it for more than we bought it at, so we're going to keep doing that. And it's going to help us fund the buildout, which is somewhat dissatisfactory at best.
Help me understand what's going through his mind and his team's mind, because this is the multi-trillion-dollar question. He knew this was coming. This is the only question shareholders have. This is the question everyone has. And he comes out and seems to filibuster. I mean, I can only glean from that that maybe he actually doesn't know what they're doing with that data center capacity. Like, what do you think is actually going through his head?
Well, we have to remember that Mr. Zuckerberg has controlling interest in Meta. He's the owner, founder, and he treats Meta as such. And when you're invested in Meta, you're along for the ride. This is much like Elon Musk's companies, especially SpaceX, right? He no longer controls Tesla. He still controls SpaceX. You're on for the ride. And if Mark Zuckerberg wants to invest because he wants to win the AI race and compete with Anthropic and OpenAI, he gets to decide to do that. He doesn't have the type of governance that many of the other companies that we talk about — we'll talk about a good one, Microsoft, soon — have. And so he could just decide to do that. This has been much to the frustration of investors over this. This is why Meta trades at such a low multiple of earnings: it's Mr. Zuckerberg's show, and he gets to decide how to run it.
Yeah. Let's pivot to Microsoft. A very different story. Investors are very excited. What did you make of Microsoft's earnings?
This is a narrative-breaking result. So Microsoft, for most of this year, has been cast aside as losing in AI because AI is so good that it's going to ruin the software business, and then AI is so bad that they're wasting money investing in data centers. And they got the raw end of both of those narratives. And what they just reported will break both of those narratives. Their software business is doing very well on the office side, on the commercial side, on the infrastructure software side. Azure accelerated after growing four quarters at around 39% and accelerated to 43%, and just got into 45% next quarter. This is a business that's more than a hundred billion dollars that's growing that fast. And so both the software side's doing well, the infrastructure side's doing well. So they're accelerating growth at the same margins, which is to say a lot of incremental profit that should be paying for those investments. But the most important thing she just did on the earnings call is let us know that capital expenditures are going to be up year-over-year from this year, right? So I want to emphasize why that wording is so important. If she said down year-over-year, all hell would break loose in the market, right? As a reaction, right? All semi stocks would get cut in half. If she said what the CFO of Google said last week — that capex is going to grow significantly and put mustard behind that significantly — then Microsoft would be in a lot of trouble, just like Google was. But she went right down the fairway and said capital expenditure is going to be up. That's very good news because if they can grow Azure at 45% and capital expenditures at a lower rate, that means cash flow is bottomed and is increasing from here. And by the way, Google's cash flow negative. Meta basically break-even. Microsoft had $20 billion of positive free cash flow in the quarter, and they just guided that they will also have positive free cash flow next year. So they delivered a great result that should really change the narrative on Microsoft going forward.
Now that you bring up Google's negative cash flow, and while we have you, I'd love to get your reactions to that. I mean, it seems like everyone is worried about childish spending when it comes to AI, irresponsible spending. It seems like Microsoft has demonstrated with this report that they are something of an adult in the room. It's hard to make the case for Google at this point. I was quite struck by that negative free cash flow that they reported. How did you feel about it?
Absolutely. It was shocking. This is one of the best businesses ever created, and they went to cash flow negative and showed intent to stay there. It was jarring.
It wasn't jarring. The market reacted appropriately to that news and really took a step back. That's why I was looking forward to this Microsoft result, because you said exactly right: they're the adult in the room. In the past, they've shown that, and they continue to show that if the returns are there, they'll invest, but they're not doing it in a big game theory, game of chicken competition with the other companies. They're doing it because it's good business, not because they feel a need to beat somebody at something or get to artificial general intelligence first or anything like that. And that's why I expect there to be a big sigh of relief across the AI trade, because if Microsoft is setting the tone as opposed to less responsible actors like Mr. Zuckerberg or, to some extent, Google, then maybe we're in better hands than we thought we are.
Yeah, just looking at the stocks of some of these names. I mean, we'll see. After-hours trading might change things, but as of close, year-to-date, Microsoft is down 18%, Meta is down 10%. Google's up 9%. Just what is your view of the valuations at this point? You mentioned how low Meta's multiple is. Where do you stand on the prices at this point?
I think the important pair here is Microsoft and Google, right? A year ago, when everybody thought Google was done, Microsoft was trading at 30 times and Google was 18 times. As of a week ago, it had completely flipped. Google was the big winner. Microsoft was the big loser. Google was trading at 30 times. Microsoft was trading at 18 times. We were expecting a reversion to the mean. And between the Google result and this Microsoft result, we're going to get it. Why should these revert to the mean? Because they're very similar companies with very similar positioning in AI. They both have very good assets to bear in the growth of AI. They're growing revenue and earnings at a similar rate. So they're very comparable. They should trade at a similar multiple. But that pendulum swung way too far a year ago. It swung in Google's favor this year. We expect there to be a reversion to the mean.
Final question before we let you go, Gil. It seems like the AI trade has had something of a shaky few weeks. I mean, the chip stocks have been getting crushed. The credit default swaps on a lot of these names like Nvidia, those have been rising. There is increased fear that a lot of these companies, these big tech companies which are now issuing billions of dollars of debt, might default, that they might not actually make those payments. Combined with this news or this reporting that we saw from Nick, basically telling us that there is almost $2 trillion worth of debt that is off balance sheet for a lot of these tech companies that is being issued in these SPVs that are largely funded by private credit firms — a lot of weirdness and concern. You cover this sector. What do you make of those concerns? Do you think that they are warranted?
