Alphabet is preferred for new investment over Microsoft due to better valuation, higher expected revenue growth, and superior ROIC and revenue per employee metrics.

So, Alphabet and Microsoft are two companies I've been interested in for over a decade. I follow these two companies closely . They are among the largest buyers of AI components and AI data center builders.

They are among the largest companies in terms of market capitalization in the United States and around the world. In addition, I own shares in both companies, Microsoft and Alphabet.

Therefore, I was so interested in the rapidly changing dynamics between them that I wanted to review them and see which one I preferred as an investment. So, when I think about which one I'm going to buy next, I want to know that and have it in mind.

Also, many people ask me in the comments section, via email, and in personal conversations, which I think is better, Microsoft or Alphabet ?

Depending on the month in which they asked this question this year, the answer may vary. Which represents a better buying opportunity at current market prices in October ?

I was impressed by the revenue growth of these two companies, but perhaps even more so with Alphabet. The reason is that Alphabet primarily offers free products and generates hundreds of billions of dollars in revenue from those free products.

Of course, this excludes the recent emergence of its own cloud computing business, which is not entirely free for the companies that purchase it. But, if you think about Google Search, Gmail, YouTube, and other products, they offer them for free to the majority of users.

They have amassed over a billion users for six different products, and they are still generating huge profits across the board . So, I was really impressed with this part of Alphabet's work .

In general, these companies generate hundreds of billions in revenue; 446 billion for Alphabet and 331 billion for Microsoft.

This represents a significant increase from a decade ago , when neither had surpassed the $100 billion mark in revenue. Now, more recently, and looking ahead, I expect Alphabet's revenue growth to outpace Microsoft's.

Alphabet is more advanced in developing artificial intelligence. It has a huge language model of its own that I would rank third after Anthropic and ChatGBT, but it is still gaining momentum, especially among Google customers who already use its advertising services or productivity packages.

It adds that, and these services are very well integrated with the core of its business.

Interestingly, while Alphabet has the revenue advantage, Microsoft has the profit margin advantage. At that time, Alphabet had a better operating profit margin than Microsoft.

Meanwhile, Alphabet's margins also increased, but not to the same extent as Microsoft's. Alphabet has a large operating profit margin of 34%.

However, comparing it to " Microsoft" makes it seem less superior.

Looking ahead, these companies' operating profit margins should continue to expand. This is due to the way AI investments are classified, where they are listed in the cash flow statement as capital expenditures, and then listed in the income statement as depreciation over several years.

This gives the investment time to reap the benefits and offset the costs. While the cash flow statements look much worse, much of that cash investment is being paid upfront now to build data centers , and then the cash is recouped over several years as the interest from those investments is reaped.

Whether you're renting computing capacity or selling tokens as part of your massive language model, you get the benefits of your investments over time.

The income statement allows you to balance these two things, and the operating profit margin is one of the items on the income statement. The return on invested capital will become increasingly important.

This is because these companies are spending hundreds of billions of dollars to build these AI data centers, and investors will want to see that the companies generate enough return to offset all that capital investment.

Historically , Alphabet and Microsoft have done an excellent job of allocating capital. Alphabet's return on invested capital has improved to 46%, up from about 15% a decade ago .

Therefore, in terms of return on invested capital, Alphabet has the advantage. Another area I'm watching closely in these companies is revenue per employee. I want to see them reap the productivity benefits of all these investments in artificial intelligence.

I want to see them use and integrate artificial intelligence into their operations to make their employees more productive. One way I look at it is revenue per employee.

In this respect, both have shown significant improvements. But again, Alphabet has the advantage here with about $2.15 million in revenue per employee, and that figure is improving significantly.

Okay, let's now take a look at the rating. Based on the future earnings multiple, they are valued similarly. Alphabet is trading at a forward price-to-earnings ratio of 22.4, while Microsoft is trading at a forward price-to-earnings ratio of 21.5.

In general, I think these ratings for companies of this quality, which I would classify as " Hall of Fame" companies, are relatively cheap ratings.

I believe it is relatively undervalued based on its future prospects and the risks associated with those prospects. I also like to look at the valuation using my discounted cash flow model.

Using this model, I estimate that Alphabet's business is valued at its fair value .

I calculated the fair value at 331. The current market price is 343. That's a difference of approximately 3.4%, which is within my margin of safety . Therefore, I would say that Alphabet's business is slightly undervalued when you look at the valuation holistically, and not just through a discounted cash flow model or market multiplier.

So, these are excellent companies. I own both of them and do not intend to sell them anytime soon at any levels close to these. But, if I were thinking about my next dollar investment, if I were thinking about my next purchase, if I had to choose now which one to buy next, it would be Alphabet because of its slightly more attractive valuation.