Over the past five years, Microsoft (NASDAQ: MSFT) has outperformed Oracle (NYSE: ORCL) by a large margin, returning 220% versus Oracle’s ∼40%. More recently, however, Oracle has started catching up, and since the lows of last year’s tech stock rout, it has returned just a few percent less than Microsoft. On the face of it, Oracle looks much cheaper, trading on a forward multiple of 14, while Microsoft’s sits at 25. So, does this mean Oracle presents an opportunity, and we are in for a period of outperformance?

Microsoft has made a huge comeback over the last decade, even managing to retain its crown as the largest company in the world for most of last year and topping a $1 trillion valuation in late trade on Wednesday. Oracle is a somewhat controversial company these days, and many are skeptical of its prospects – though clearly not everyone judging by the stock price.


Will Oracles’ Cloud Business Take Off?

When comparing the two, most of the focus is on their cloud computing businesses. By all accounts, Microsoft’s Cloud offering, Azure, is its primary growth driver. On Wednesday, Microsoft released results which included sales growth of 73% from Azure despite coming off a very high base.

Oracle is still a very profitable business, it’s just not really winning in the growth areas that the rapidly growing software businesses are.

The company has now embraced cloud computing, and Chairman Larry Ellison is confident that customers prefer its cloud computing to those of its competitors. However, the company is somewhat opaque when it comes to just how big its cloud business is. Cloud-services and license-support revenue contribute 70% of revenue, but that figure is not broken down further.


Beyond the Cloud

Oracle’s strength is the high switching costs that companies using its software will face if they move.

While cloud services are Microsoft’s growth driver, its other businesses are still experiencing robust growth. Its productivity suite, Windows subscriptions, and OEM products all grew sales by double digits. The company’s margins prove it still has pricing power in these areas too. In short, Microsoft is not a one trick pony.

Oracle’s strength is the high switching costs that companies using its software will face if they move. That’s a great moat when it comes to defending its legacy revenue streams, but it’s not going to generate growth. Until we see revenue growth or a breakdown of the growth Oracle’s cloud services are experiencing, there is little reason to believe the company can grow much more than 10% a year.


Risks to the Downside For Both Companies

If Oracle’s cloud business does indeed gain traction, it would be a different story. But, until it starts surprising meaningfully on the upside, there will be no evidence of that happening.

Since 2006, Oracle’s price to sales ratio has been between 3 and 5.54 and currently sits at 5.43. If revenue growth is unlikely to grow at more than 10%, and the operating margin is already relatively high, that price to sales ratio is unlikely to sustain levels above 5.5.

Oracle has been engaged in a stock buyback scheme for the last year, and it seems that has been the main driver of the price. If revenue growth doesn’t accelerate, if, or when, that buyback program ends the risk will be to the downside. In the short term, however, there may still be an opportunity to ride the momentum.

Overall, Microsoft has far more going for it and holds lots of promise for the future. However, its cloud business is coming off a very high base and is already beginning to slow. There is every chance it will disappoint in one of the next few quarters – and that may offer investors a better entry than current levels.

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