Big Tech Stocks Flash Red Flag to Regulators After Q1 Earnings Splash

If “Big Tech” was a gamefish, like Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Tesla (NASDAQ:TLSA) made a big earnings splash this week. Results and guidance were handily above expectations for many tech stocks, so growth investors didn’t mind getting wet. But, for industry observers and regulators looking to reel it in, this quarter’s results didn’t help soothe fears of Tech’s rising dominance.

people gathered around a computer collaborating

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Riding an accelerating digital adoption curve, the tech titans appear to only be getting bigger.

Those profits are going to two places: Product development, with Artificial Intelligence (AI) at the top of the list. They’re also being used to grow tech company cash coffers, funding investments in cryptocurrencies like Bitcoin (CCC:BTC-USD).

The digital transformation tide shows no signs of receding. And with that, the debate over Big Tech’s circle of influence, and whether it should be regulated, looks set to intensify. What happens when the titans, social media and investors collide? One thing’s certain: It could have a big impact on investor portfolios. It could also make the music stop at one of the biggest retail finance parties ever (Roaring Kitty, I’m talking to you).

Here’s what happened to tech stocks recently and how to stay ahead.

Big Tech Stocks: Made for Lockdown

For tech investors, if it wasn’t clear already, this quarter’s earnings underscored the enormous effect of a pandemic on the digital transformation of education, healthcare, remote work and e-commerce. Tech companies, particularly those with exposure to social networking and Cloud, were seemingly made for lockdown. That rising tide was reflected in the strong revenues and profitability we saw across the board for tech stocks this quarter.

But the numbers also tell another story: The digital adoption curve isn’t slowing. Take Microsoft, whose revenue hit almost $42 billion this quarter, up 19% from a year earlier. That’s the biggest quarterly increase since 2018. Profits similarly jumped 44% to $15.5 billion. The reason should now come as no surprise: Commercial Cloud and Office 365 products, which grew 33% and 22% year over year, respectively.

Investors fearing a market getting ahead of itself saw nothing spooky at Facebook and Google. Both titans reported stronger-then-expected advertising revenues that suggest we’re still very much in growth mode. Facebook’s average price per ad increased 30% and it experienced a 12% increase in ads shown. Mark Zuckerberg threw out a big number: 2.85 billion people use the leading social network monthly (up 10% year over year). Monthly usage of Instagram, WhatsApp and Messenger is even bigger: 3.45 billion.

Also part of the widening circle of Tech influence is Google, which saw a 32% increase in revenue this quarter to nearly $45 billion — the company’s third consecutive quarter of accelerating ad growth. Apple joined in to offer proof the reopening trade isn’t over. The tech giant reported FQ2 revenue of almost $90 billion, up 54% year-over-year.

More Earnings Flowing to AI

Tech investors didn’t just get the scoop on what’s driving growth. They also saw where those profits are going. For Facebook, it’s going to deeper investment in virtual and augmented reality and AI, which according to Mark Zuckerberg, have the “potential to change the trajectory of the company over the long term.”

Microsoft has also been walking the AI walk. The company, still hot from its $16 billion acquisition of Nuance only three weeks ago, commented on an emerging “second wave” of global digital transformation. While Nuance clearly gave Microsoft a subtle play in the healthcare sector, the move is much more about boosting its capacity in AI and speech recognition software.

There’s enough here to see that Big Tech is focusing its lens on the intersection between humans and technology. With more mergers and acquisitions (M&A) ahead, investors who want to play in this space should continue to invest in the key themes: AI, Big Data and blockchain ecosystem. Names like Palo Alto Networks (NYSE:PANW), Splunk (NASDAQ:SPLK), Salesforce (NYSE:CRM) and Nvidia (NASDAQ:NVDA) remain my favorites right now.

Bitcoin Bets

Product development isn’t Big Tech’s only growth lever. Just ask Elon Musk. At Tesla, those dollar signs on the balance sheet aren’t just cash. They now include a big chunk of cryptocurrency.

This week, investors got a closer peek at Tesla’s Bitcoin horde. No one should be surprised Tesla made big profits in Bitcoin. The company already disclosed a $1.5 billion Bitcoin stake in its 10K dated Feb. 8. The eye-opener is how much and when. After a Twitter-sphere explosion over a potential Elon Musk-sponsored Bitcoin pump-and-dump scheme, Tesla’s response recharged the crypto rally (for now).

The company sold an estimated 10% of its crypto holdings “to prove liquidity of Bitcoin as an alternative to holding cash on balance sheet.” Musk assured investors that he’s keeping all his coins, backed by CFO Zachary Kirkhorn’s pledge that Tesla is a long-term holder.

Liquid Balance Sheets

The Bitcoin on Tesla’s balance sheet reveals another important truth. Tesla’s Bitcoin profits are almost as important as the profitability of its actual business of selling electric cars and batteries. In Q1, Tesla paid $171 million for Bitcoin which it later sold for $272 million. That $101 million “positive impact” is a sizable chunk of the company’s $594 million in total operating income for the quarter.

For Tesla investors, that profit is a huge win for a company that has only been trading Bitcoin for a single quarter (Tesla has been producing cars since 2008). But, it also means the company’s profitability is increasingly tied to a very volatile investment.

Given crypto’s wild fluctuations, the bigger this holding gets as a piece of Tesla’s balance sheet, the murkier the view into the company’s already unpredictable earnings. Some observers question how companies should account for their crypto, and what they should do with any profits. When times are good, that could mean paying a special dividend with this excess cash, and letting the shareholders decide whether to buy Bitcoin or do something else with the cash.

How Big Is Too Big?

Investors interested in tech stocks will come away feeling good about this quarter’s numbers. But not everyone will be sharing those vibes. Industry observers and lawmakers calling for increased regulation, higher taxes and stronger antitrust enforcement won’t appreciate Tech’s increasing sphere of influence. Add to that a backlash surrounding privacy, security and safety, a new presidential administration and a new Congress, and we may be brewing a recipe for U.S. Tech legislation.

The partisan divide is bitter, which suggests any potential regulatory changes could have far-reaching implications for investors. Conservatives argue that Big Tech has too much power. Liberals argue that social media platforms don’t do enough to stem misinformation.

Right now, of all the proposals calling for change to Section 230, the PACT (Platform Accountability and Consumer Transparency) Act is the only one with support from both parties and (potentially) Big Tech. PACT would require online platforms, including Facebook and Google, to provide more transparency around their content moderation decisions and policies.

Is the Reddit Party Over?

But investors should be aware that the needle could swing the other way — particularly if the Justice Department gets oversight over how Tech companies encrypt users’ data. Right now, Facebook and other large internet companies use end-to-end encryption. This tech keeps data encrypted for anyone outside a conversation, including the companies themselves. Facebook has added end-to-end encryption to Messenger and Whatsapp and is reportedly pushing it for other services.

Anyone trading on popular social networks like r/WallStreetbets or getting financial advice from Twitter, Instagram or Youtube: take note. Any regulation that gives law enforcement a backdoor to social content is a big deal for tech stocks.

In the same way that Craigslist no longer offers personal listings owing to potential liability issues, popular social websites and individual influencers could also be punished or restricted for not providing trusted information. This enforcement would grind to a halt the kind of coordinated investing among retail investors that made big “gamma squeezes” like Gamestop (NYSE:GME) and Microvision (NASDAQ:MVIS) possible.

On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.


Article printed from InvestorPlace Media, https://investorplace.com/2021/04/big-tech-stocks-flash-red-flag-to-regulators-after-q1-earnings-splash/.

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