MSFT has strong fundamentals (margins, productivity) but is slightly overvalued by DCF ($420 vs $509).

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.

Meanwhile, Microsoft has already reaped the rewards of its investment in its Windows operating system. That fundamental competitive advantage it possesses in this category has been reflected in all the other advantages that Microsoft has built upon this foundation.

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.

At the same time, Microsoft is investing in developing its own massive language model. One of the downsides of Microsoft here is that it is closely linked to OpenAI, and investors are deducting part of Microsoft's value because of this link, due to their concern about the financial situation of ChatGBT and OpenAI.

Interestingly, while Alphabet has the revenue advantage, Microsoft has the profit margin advantage. Microsoft's operating profit margin jumped to 47%, up from about 25% in 2017.

At that time, Alphabet had a better operating profit margin than Microsoft.

But over the past decade, Satya Nadella and the team at Alphabet have done a great job of improving margins. Meanwhile, Alphabet's margins also increased, but not to the same extent as Microsoft's.

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. Microsoft's return on invested capital is not increasing.

In fact, it is dropping to 26% from a peak of around 32%. 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. Microsoft is also benefiting from this, as its revenue per employee jumped to $1.47 million.

And you can see over the past year and a half that the curve of that growth has really accelerated. This is the time when we have truly seen investments and the spread of agent AI, which greatly enhances productivity for each employee .

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.

Meanwhile , for Microsoft, I calculated a fair value of $420, while the current market price is $509.

Here I see a difference of more than 17%. So, using my discounted cash flow model, I would say that Microsoft stock appears to be slightly overvalued.

While it appears to be undervalued when I look at it on a futures earnings multiple basis . So, overall, I would say that Microsoft stock appears to be fairly valued at current market prices.

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.