The market, measured by the S&P500 (SNPINDEX: ^GSPC)recently recorded new all-time highs. However, not every stock in that index participated in the rally. Two that are still below their all-time highs and haven’t shown much life lately are Microsoft (NASDAQ: MSFT) And Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL).
These two companies are often seen as leaders in the artificial intelligence (AI) arms race, so why are their shares falling?)
Neither stock is near an all-time high
These two stocks haven’t quite kept up with the S&P 500’s latest rally, as both stocks are down about 10% or more since the last time the S&P 500 posted a new all-time high in mid-July.
GOOGL Total Return Level data per YCharts
Additionally, both companies posted strong second-quarter results in that time frame, with Microsoft delivering 15% year-over-year revenue growth and 10% earnings per share (EPS) growth (these results were for Microsoft’s fourth quarter fiscal 2024, that ended on June 30). ). Alphabet’s turnover increased by 14% and earnings per share by 31% in the same period.
Clearly neither company is doing terribly from an operational perspective, so why haven’t these two joined the rally that others have benefited from?
Each stock has its own reasons.
Microsoft
Microsoft emerged as one of the top AI companies due to its strong partnership with OpenAI, the maker of ChatGPT. The company also integrated ChatGPT into Copilot – Microsoft’s version of a generative AI assistant. This created a huge hype behind Microsoft and quickly earned it a premium price tag.
MSFT PE Ratio (Forward) data per YCharts
In late June, Microsoft traded for an expensive 38 times forward earnings, and that price tag has dropped quite a bit to the current 32 times forward earnings. Considering that the S&P 500 trades at 23.5 times forward earnings and that Wall Street expects Microsoft to grow earnings per share 11% in fiscal 2025, the stock is still expensive.
This is likely why Microsoft didn’t participate in the latest rally, as it already has fairly high expectations baked into its stock price. Microsoft’s premium valuation could continue to evaporate if the company continues to post mundane quarters of market-beating growth.
Still, Microsoft shares are at a significant premium to the market despite delivering average growth. As a result, I will likely stay away from the stock until growth can increase or the premium falls.
Alphabet
Alphabet’s stock trades at about 21.1 times forward earnings, which is less than the valuation of the S&P 500. So the valuation argument that applied to Microsoft is completely irrelevant to Alphabet.
That doesn’t mean the market has Alphabet wrong, because Alphabet has a number of other problems under the hood.
Investors’ main concern is whether Alphabet will exist in its current state in five years. Multiple lawsuits have been filed against Alphabet for anticompetitive practices, and the DOJ is considering breaking up Alphabet into several pieces as a result. This makes it difficult to analyze the company because investors aren’t sure what it will look like in a few years.
Furthermore, the majority of Alphabet’s revenue comes from advertising. Advertising can be a fickle industry that declines when companies sense a recession is coming. So just because Alphabet is doing well right now doesn’t mean it will continue that success in a year or two.
However, since Alphabet is trading at a lower price than the market despite strong growth, I think it can be bought now. The breakup of the DOJ would likely be years away, as Alphabet would challenge it in court, which would likely end up all the way to the Supreme Court after multiple appeals.
The recession risk exists for the advertising sector, but that risk applies to all companies, so this is not a problem unique to Alphabet.
Alphabet stock has value, and I wouldn’t be surprised if it sees an increase in the near future as it returns to at least market average prices.
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Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Keithen Drury has positions in Alphabet and Vanguard S&P 500 ETF. The Motley Fool holds positions in and recommends Alphabet, Microsoft and Vanguard S&P 500 ETF. The Motley Fool recommends the following options: long January 2026 $395 calls to Microsoft and short January 2026 $405 calls to Microsoft. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
