Tech Giants Fall

Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Everyone has an Achilles heel, even Microsoft (NASDAQ: MSFT) and Google (NASDAQ: GOOG). These two tech giants hit a strong headwind recently, with Microsoft plummeting by over 11% in one day, while Google shaved a little off its market cap.

Microsoft reported earnings that dismayed investors, as it took a $900 million writedown on its Surface tablets. The writedown came after Microsoft cut the price on some of its tablets by as much as 30%.

Missed by a mile

Microsoft reported earnings of $0.66 per share (excluding the write down) on $19.9 billion in revenue, missing estimates of $0.75 per share and $20.73 billion of revenue. If you factor in the write down then Microsoft earned $0.59 per share. Revenue was up 3% and operating income was down 11% to $6.2 billion. 

The Windows unit saw sales of $4.4 billion, which missed expectations by $400 million as PC sales continued its free fall. This comes as the CFO stated that consumer PC sales fell by 20%.

On the plus side, Microsoft saw 9% revenue growth (year over year) in its Servers and Tools business, with data and system centers posting 14% growth and SQL servers posting 16% growth. It's Azure cloud offering added 25% more customers and in the conference call Microsoft said that Azure is now in over 50% of the Fortune 500 companies.

Where Microsoft is doing well is on the business and enterprise side of things, while the consumer side remains a heavy drag. If you look at the Microsoft Business Division, total revenue was up 2% with business growth hitting 7% while consumer revenue fell by 27%. The one area that Microsoft is seeing growth is in the entertainment division.

Revenue in the Entertainment and Devices Division grew by 8% (year over year) with Xbox Live transaction revenue growing by 20%. While the Xbox side of Microsoft is only a small part of its overall profit, it offers some downside protection from the other consumer side of things.

The world's most interesting bond

Microsoft's stock hasn't gone anywhere over the past decade, so I have dubbed it the world's most interesting bond, paying out a 2.6% dividend with a payout ratio of 34.1%. Microsoft will continue to boost its payout ratio through good times and bad as its business side grows at a steady rate.

The consumer side is still a big drag on Microsoft and will be for at least 2 more years because there is little need to upgrade your PC while wages are still stagnant or falling. During the recession, wages in the US fell by 4% in real terms and by another 4% since it has ended. Consumers won't upgrade their PC's until they feel like they can afford it. Within 2 years Europe should at least see its unemployment rate (now at 12.2%) hold, and the US will start to see wage gains once again.

This will spur more consumer spending and PC sales will begin to rise again, boosting Microsoft's revenue and profits once again. As of now, I would rate Microsoft a hold, with strong business growth being weighed down by a declining consumer side, with a nice 2.6% dividend to balance things out.

Intel feels Microsoft's pain

Intel (NASDAQ: INTC) is another casualty of the declining PC market. Intel forecasted third quarter sales of $13.5 billion (plus/minus $500 million), which was $200 million less than estimated. Intel posted an EPS of $0.39 ($2 billion), which missed estimates of $0.39 and was down 29% from $0.54 ($2.83 billion) a year ago. Sales fell 5.1% to $12.8 billion, missing estimates for $12.9 billion.

Intel's PC division saw revenue fall by 7.5% to $8.1 billion. According to IDC Intel supplies 9 out of 10 PC based chip servers, but less than 1% of smartphone processors. In order for me to turn bullish on Intel I would have to see it move aggressively into the smartphone market.

If it did, it would be able to compensate for the drop in the PC market and the stagnation it saw in server chip sales, which grew by less than 1% to $2.7 billion in revenue. On the plus side, Intel does control 6% of the tablet market according to Strategy Analytics, and the tablet market is growing faster than the smartphone market.

I have a hold rating on Intel, as the declining PC market won't turn around for at least 2 years and it has yet to gain a strong enough foothold in either the tablet or smartphone market for me to be bullish. It does, however, pay out a nice 3.9% dividend and trades at a PE of 12.3, but with the PC side of things dropping earnings heavily, I would stay away from Intel right now.

Search this

Paid clicks up 23% for the quarter, but the cost per click was down 6%. This made investors fear that Google's (NASDAQ: GOOG) growth rate was slowing down and sent shares down a bit. Google's revenue was up 19% to $11.1 billion (missing estimates) and income was up 16% to $3.23 billion, or $9.54 per share (missing estimates).

The reason why Google's cost per click was down 6% this quarter and 2% last quarter is because of its switch to mobile. Mobile clicks cost 40% less than those on a PC. One bullish bit in Google's earnings was that the 23% increase in paid clicks was more than the 19% estimated. If Google can keep increasing the total number of paid clicks then it can balance out the drop in the cost per click.

The paid clicks are when someone clicks on an ad sponsored by Google, such as by a travel site that is advertising on a site related to Hawaii. The cost per click is the price that advertisers pays Google for each click Google generates. If the cost per click goes down, then Google has to compensate by increasing the total number of paid clicks.

Google trades at a hefty 26 PE but at a more reasonable forward PE of 17.5. If you look at this quarter, you may think Google will more likely have a forward PE of 20-25, but if you look at Google's past 9 earnings releases it has only missed twice. Google is a fairly consistent performer and could see its stock hit $1,000 by the end of 2013.

As more smartphones running Android are sold, the number of paid clicks will increase as Google's Mobile OS is very closely entwined with its search engine. Looking at first quarter IDC numbers, there were 162.1 million Android smartphones shipped, which is a huge gain on the previous year of 90.3 million smartphones shipped.

Going forward, Google has the Moto X, a smartphone being launched by Motorola (which Google bought for $12.4 billion) later in the year. That, combined with more info on Google Glass and more paid clicks should drive Google to $1,000 by the end of the year. Bullish on Google.

Final thoughts

It seems that the theme of tech this earnings season was dread from plummeting consumer PC sales. Microsoft's business side of things held up nicely, Intel has a chance to move into mobile, and Google grew total paid clicks more than expected, but was blindsided by a drop in paid click costs. As long as PC sales continue to slide, Microsoft and Intel are going to keep seeing their stock prices in the doldrums or falling.

Mobile is the way out, which is why Google is heading for $1,000 a share. If Microsoft and Intel can find a way into mobile then they too will have a big chance at success. Microsoft also needs to focus on its cloud offering and business side of things, as that has done very well over the past few years and should continue to do so.

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Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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