Microsoft and Tesla Share a Common Concern, but Here's Why One Is Much More Justified

For a large portion of the year, Microsoft (NASDAQ: MSFT) and Tesla (NASDAQ: TSLA) were the two worst-performing "Magnificent Seven" stocks, but they've gone in two different directions since their latest earnings reports. As of market close on Aug. 11, Microsoft is up 6.5% year to date (YTD), and Tesla is down 24% YTD.

One common complaint investors have shared among them is their high capital expenditures (capex). They're not comparable in scale -- Microsoft spent $41 billion in its recent quarter (up 70% year over year), while Tesla spent $5.8 billion (up 142%) -- but they're putting a noticeable dent in both companies' finances.

Even so, Microsoft's high capex is much easier to justify, which is why it's still a buy.

It's hard to overlook free cash flow

A company's free cash flow is important because it's money available for things such as dividends, share buybacks, and reinvestment in the business. Capex cuts directly into free cash flow, reducing a company's financial flexibility and ability to put the money to use elsewhere.

Even after spending $41 billion this past quarter, Microsoft's free cash flow was still $19.6 billion. Tesla's free cash flow came in negative, burning through $1.1 billion.

It's much easier to justify Microsoft's capex because it has the cash flow to absorb the costs without jeopardizing its financial health. It might not be ideal from a financial discipline standpoint, but Microsoft is a massive business and cash cow that has much more financial leeway than Tesla.

Immediate versus future results

The spending itself isn't inherently the problem; the issue is when investors can expect to see results from it. Investors are aware that the spending is a means to an end, but it helps when the end is visible or predictable.

In Microsoft's case, concerns were that heavy spending on data centers and AI infrastructure would erode cash flow and profits before a return on investment was seen. However, after its recent earnings report -- which revealed that its cloud platform, Azure, had its first $100 billion year and a $678 billion backlog -- many of those worries have been laid to rest.

Tesla's spending is mostly going toward much longer-term projects, such as its Optimum robots and robotaxi network. Both are intriguing projects but are realistically very far off from becoming meaningful revenue generators (assuming they do). They're even further from becoming profitable businesses that Tesla can rely on.

As an investor, I'm much more encouraged by Microsoft's spending and direction. It's a stock I would load up on, while Tesla is one I'm avoiding.

Stefon Walters has positions in Microsoft. The Motley Fool has positions in and recommends Microsoft and Tesla. The Motley Fool has a disclosure policy.