Better Artificial Intelligence (AI) Stock: Alphabet or Microsoft

Artificial intelligence (AI) stocks come in all varieties, but two of the biggest on the market are Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL). Both of these companies are known as AI hyperscalers, as they are rapidly building out the computing footprint necessary to handle a vast amount of AI workloads. This includes pouring hundreds of billions of dollars into capital expenditures to build out data centers to support AI.

But between the two, which is the better buy?

Image source: Getty Images.

Both companies have a variety of business units

Few companies get as large as Microsoft and Alphabet by just offering a handful of products. Both of these tech giants have countless offerings, including some overlap.

Microsoft is most famous for its business productivity tools, but it also has other platforms like LinkedIn and the Xbox ecosystem to diversify its main product lineup. Alphabet owns Google and YouTube, alongside many other platforms. However, the biggest overlap between these two is in the cloud computing space, which is also the biggest area where these two are seeing AI demand.

At its core, cloud computing involves building out excess computing resources, then renting that extra capacity back to customers. This is more convenient than on-premises hardware, as clients don't have to maintain the equipment; they just rent it from Google Cloud or Microsoft Azure. Renting also allows clients to scale up or down easily without having to spend a ton of money up front on hardware. Countless AI start-ups are utilizing Azure and Google Cloud as places to build, train, and run AI models.

But which company has the better offering?

If you judge solely by growth rate, then it's Google Cloud. In the first quarter, Google Cloud's revenue rose 63% year over year, while Azure's increased 40%. However, that doesn't tell the full story. Alphabet also includes sales of its Tensor Processing Unit (TPU) computing chip in its Google Cloud segment results, so this is a boost that Azure doesn't have. As a result, it's difficult to directly compare how successful the core cloud computing units are. However, TPU sales are one advantage Alphabet does have over Microsoft, so I'm going to give this category win to Alphabet.

Winner: Alphabet

Each is seeing strong growth

Both companies recently announced relatively strong quarterly results. Alphabet's overall revenue growth came in at 22%, with its operating income rising 30%. Microsoft's quarter was slightly weaker, with revenue rising 18% and operating income increasing 20%.

At face value, Alphabet clearly had the better quarter. Microsoft's quarter was fantastic as well, but when Alphabet clearly has the advantage, it's tough to give the win to Microsoft.

Winner: Alphabet

Alphabet's latest rally has made the stock expensive

At two wins to zero, Microsoft can't make a comeback and win. However, nobody said the categories were weighted equally. It's not like Microsoft outright lost the other two categories; it was extremely close. Valuation is a key consideration, and if one stock is significantly more expensive than the other, it may be the better option.

To value each company, I am going to use operating cash flow. Currently, both companies are spending heavily on capital expenditures and their investments are rising in value. This skews the free-cash-flow and net income metrics, rendering them useless in a valuation analysis.

MSFT Price to CFO Per Share (TTM) data by YCharts

For a long time, Microsoft was valued at a higher premium, but that's no longer the case. Now, Alphabet trades at decade-high levels, while Microsoft is near decade lows. That's a pretty stark contrast and shows that Alphabet's recent rally may have been a bit too much.

On the flip side, Microsoft looks like a strong bargain.

So, despite Alphabet looking like the healthier company, I think Microsoft is the better investment solely due to its dirt cheap price tag.

Keithen Drury has positions in Alphabet and Microsoft. The Motley Fool has positions in and recommends Alphabet and Microsoft. The Motley Fool has a disclosure policy.