Alphabet and Microsoft look like gems in the rubble of the tech sector

The tech-heavy Nasdaq index, which is frequently used as a benchmark for the tech sector, has crashed into a bear market. The index has fallen 22% from its record high close last November.

However, as my colleague Max King points out, the valuations of many quality growth stocks are now either “attractive or very attractive,” after being dragged down with the rest of the market.

As I recently noted – If you’re going to buy FANG stocks today, these are the three to focus on – companies with substantial competitive advantages and unique products are likely to pull through this turbulence, while corporations that lack any conceivable advantages over the competition are likely to continue to struggle.

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We’re already seeing this trend play out in figures from the streaming giant Netflix (Nasdaq: NFLX) and Facebook’s parent company Meta (Nasdaq: FB). These corporations are losing market share to competitors and there are plenty of other examples.

Peloton (Nasdaq: PTON), down 80% in a year, is just an exercise bike with a computer attached. Affirm (Nasdaq: AFRM) a “buy now pay later’’ company, has cratered 80% since November. Its product operates in a very similar way to credit cards. Robinhood (Nasdaq: HOOD), down 72% from its IPO price, is now just one of many online stockbrokers that offers fee-free mobile app trading.

None of these organisations offer anything new or unique, and all face stiff competition.

For a company to succeed in the long-term it needs to have a niche, and it needs to defend that niche from the competition.

On that front, at the other end of the spectrum we have corporations such as Google‘s parent Alphabet (Nasdaq: GOOG) and Microsoft (Nasdaq: MSFT).

Google’s competitive advantage keeps the competition at bay

Alphabet disappointed the market by reporting a $1.5bn drop in profits for the first three months of 2022 compared to the fourth quarter of 2021. A worse-than-expected performance from YouTube was the biggest disappointment. YouTube revenues only rose 14% to $6.9bn, below the $7.5bn expected by Wall Street analysts.

Overall, the company reported a 23% rise in revenue for the quarter to $68bn, slightly below the $68.1bn expected by analysts.

YouTube’s lacklustre revenue growth reflects the wider trend in the streaming and online content sector. Consumers and advertisers are overwhelmed with too much choice, and they are starting to refocus where they spend their time and money. This is the same headwind that Netflix and Facebook are having to deal with.

YouTube may have more than two billion daily users, but it’s not a unique service. Platforms such as Tik Tok and Instagram are copying its business model, and they’re not the only ones. The lack of any competitive advantage is harming the company’s growth. I would not be surprised if this trend continues.

But where Google really has the edge is in search and services. Both of these divisions reported blow-out performances for the first quarter. Revenue from Google Search jumped 24% year-on-year to $39.6bn. The division now accounts for 58% of total revenue. Meanwhile, Google Cloud revenues expanded 44% to $5.8bn.

These divisions have huge competitive advantages. Google Search is one of the digital world’s most valuable assets. The Google brand alone is worth $263bn. It also has over two decades of data available to help users find the information they need. To back up its brand and data avantage, Google owns over $100bn of assets, mostly data centres, to process information and power Google Cloud.

Based on these numbers, a competitor would need around $400bn to build a brand capable of taking on Google in the search and cloud business. That’s out of reach for all but a tiny fraction of the corporate world.

Microsoft: a vital service for the corporate world

Microsoft exhibits similar competitive advantages. It has a world-renowned brand and has spent tens of billions building the infrastructure and software required to create and sustain a world-leading cloud and computer services business.

The company’s first quarter figures support this idea as revenues during the three months to the end of March jumped 18% to $49.4bn, beating Wall Street expectations.

The “more personal computing” division, which includes its PC and gaming businesses, reported revenue growth of 11%, while intelligent cloud revenue jumped 26% and the productivity and business process unit grew 17%. The company also revealed that demand for its cloud services is accelerating as customers press ahead with the digitisation plans.

In many respects, cloud computing is already a commoditised industry, but Microsoft and Google stand out because they offer services as well. They offer access to services such as AI systems and the suites of Microsoft Office and Google Workspace – all valuable resources for other businesses.

Bargains are emerging from the rubble of the tech sell-off, but investors need to be careful. The world of business is only becoming more competitive, and companies without a durable advantage are going to continue to struggle.

My money’s on stocks like Alphabet and Microsoft, which have a clear advantage over the competition and the resources to keep improving the customer experience.