You may know and use Google‘s popular products daily. But have you considered investing in parent company Alphabet‘s stock? With shares down over 30% from all-time highs, is now the time to buy?
Let’s analyze the tech giant’s business and valuation metrics in detail to determine:
Is Alphabet stock undervalued for long-term investors today?
We’ll start by briefly tracing Google‘s origins and expansion into the Alphabet conglomerate over the past two decades…
From Search Engine Startup to $1.2 Trillion Behemoth
Founded by Stanford PhD students Larry Page and Sergey Brin in 1998, Google began as a simple search engine. The company’s PageRank algorithm, named after co-founder Larry Page, proved more effective at providing relevant search results than existing solutions.
As Google Search’s dominance grew, the company rapidly developed and acquired new technologies across:
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Advertising: AdWords and DoubleClick acquisition now power Google Ads used by millions of businesses
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Entertainment: 2006 acquisition of video streaming site YouTube now draws over 2 billion monthly active users
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Mobile: Android mobile operating system powers ~80% of smartphones globally
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Cloud Computing: Google Cloud Platform provides IaaS, PaaS and SaaS to enterprises
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AI: Investments into machine learning across speech recognition, computer vision, robotics and quantum computing
Today, Google services are deeply integrated into daily life. From the classroom to the boardroom, it’s hard to go through a day without using a Google product!
After multiple stock splits, initial $10,000 invested in Google at its IPO would be worth over $2 million today.
Now operating under holding company Alphabet since 2015, Google accounts for over 80% of its total revenues.
Alphabet remains one of the world’s most valuable companies with a market cap exceeding $1.2 trillion as of January 2023.
Where Does Google Make All This Money?
For investors, understanding a company‘s underlying economics is key before buying its shares.
So where does Google actually make money from?
Alphabet primarily monetizes the popularity of its free services through digital advertising. Google‘s ad platform connects companies to customers using tools like:
- Google Search: ads on search engine results pages
- YouTube: video ads before clips and display ads on site
- Google Display Network: ads on partner websites/apps using Google ad tech
- Google Maps: ads promoting local stores, apps and products
This advertising segment regularly contributes over 80% of Alphabet‘s quarterly revenues and even higher share of operating profits due to its high margins.
Outside of advertising, other revenue sources include:
- Google Cloud: provides IaaS and PaaS enterprise services
- Google Play: app downloads/in-app purchases
- Hardware: Pixel smartphones, Nest and Fitbit devices
Now let‘s analyze the impressive growth and profitability metrics putting Alphabet in an enviable competitive position…
Strong Top Line Growth
Over the past 5 years, Alphabet has delivered over 20% year-over-year revenue growth per quarter on average:
| Year | Revenue | Y/Y Growth |
|---|---|---|
| 2018 | $136.8 billion | 23% |
| 2019 | $161.9 billion | 18% |
| 2020 | $182.5 billion | 13% |
| 2021 | $257.6 billion | 41% |
| 2022 | $283.4 billion* | 20%* |
(*Latest four public quarters annualized)
Double-digit revenue expansion highlights the resilience and growth potential of Alphabet‘s ad and cloud businesses despite economic challenges.
Alphabet also routinely generates robust free cash flows exceeding $65 billion in recent years. This funds large investments into AI research, connectivity initiatives like Google Fiber and other moonshot projects at X labs.
Excellent Profitability
In addition to top-line growth, Alphabet operates with superb efficiency:
- Operating margins consistently 25%+
- Net income margins in high teens
- Industry-leading return on invested capital (ROIC) averaging 17%
The hugely profitable core advertising business subsidizes loss-making units like Waymo self-driving cars allowing them room to experiment.
Valuing Alphabet Stock: Is GOOGL Undervalued?
With a solid understanding of the key drivers behind Alphabet‘s success, let‘s analyze whether the stock presents good value for investors today.
The following comparison versus technology peers highlights why most analysts remain bullish on GOOGL amidst the selloffs of 2022.
| Key Valuation Multiples | Alphabet | Microsoft | Apple | Average S&P 500 Tech Stock |
|---|---|---|---|---|
| Next 12m P/E | 18.7x | 26.1x | 22.3x | 23.5x |
| EV/EBITDA (TTM) | 11.2x | 20x | 28x | 18.2x |
| PEG Ratio | 1.13 | 1.97 | 1.25 | 1.86 |
| P/FCF (TTM) | 18.3x | 26.4x | 23x | 25.1x |
With above-average growth paired with below-average valuations, Alphabet stock appears meaningfully undervalued today.
It deserves a premium given its substantial lead in areas like digital advertising and artificial intelligence.
What Could Propel GOOGL Stock Higher?
Given Google‘s entrenched positioning across web search, digital ads and mobile operating systems, analysts expect healthy growth in 2023 and beyond from:
1. Core Google Search and YouTube
Over 85% of Alphabet‘s revenues still come from advertising. As marketing shifts further towards digital channels, Google‘s platform benefits enormously.
YouTube now draws over 2 billion monthly active viewers – a captive audience ripe with ad monetization potential.
2. Booming Google Cloud Business
Google Cloud Platform (GCP) is the company‘s next big growth engine:
- GCP quarterly revenue currently around $6 billion
- Growing over 35% annually as more workloads shift to the cloud
As the #2 after Amazon AWS with under 10% market share, the runway for growth remains massive.
Business analytics firm Gartner predicts GCP will overtake Microsoft Azure for the #2 spot by 2025.
3. Potential New Catalysts
Other potential share price catalysts include:
- Growth from Google Play app store and hardware devices
- Waymo robotaxi service scaling up
- Margin expansion from increasing cloud mix
- Initiation of dividends/buybacks once growth moderates
Of course current headwinds around ad spending weakness and regulatory scrutiny could limit near-term upside.
However, Wall Street analysts remain bullish on GOOGL over the next 12 months:
| Firm | Analyst | Price Target | Upside |
|---|---|---|---|
| Morgan Stanley | Brian Nowak | $135 | 36% |
| JP Morgan | Doug Anmuth | $134 | 35% |
| Average Price Target | $129 | 30% |
So what’s the verdict? Let’s summarize the investment thesis…
The Verdict: Alphabet Stock Offers Compelling Value Today
For investors with at least a 3 to 5 year time horizon, GOOGL stock offers an attractive risk-to-reward proposition at today‘s valuation given:
- Leadership in secular growth markets like digital advertising and cloud
- Trading at a significant discount compared to history and peers
- Consistent revenue expansion, solid profitability and robust cash generation
- Potential additional upside from emerging businesses as AI investments bear fruit
Any near-term volatility due to macro uncertainty or regulatory overhangs should offer long-term investors opportunities to accumulate shares.
With strong conviction in the management team’s ability to maintain dominance thanks to continuous innovation and strategic acquisitions, this technology bellwether likely remains a core portfolio holding for years to come.
Does this analysis help you decide whether to buy Alphabet stock? Let me know what other technology stocks you’d like me to cover next!
