Since its 2004 initial public offering, Alphabet Inc. (ticker: GOOG, GOOGL) has been one of the world’s top performing investments. Its shares are up more than 5,000% from when they went public 17 years ago.
In 2015, the company changed its name from Google to Alphabet to reflect its expanding range of businesses. That said, the core business has stayed largely the same. Alphabet continues to operate the planet’s leading search engine and advertising platform. Over the years, it has bolted on other top-notch businesses such as YouTube and Google Cloud.
After such a long run, however, some analysts are wondering if Alphabet can keep the good times rolling. The company is running into mounting regulatory headwinds as critics demand antitrust enforcement against the advertising giant. According to these voices, Alphabet holds too much sway over various parts of the online ecosystem, driving down its partners’ profits while stifling free commerce. There are concerns around Alphabet’s capital allocation and some recent strategic decisions, as well.
Here’s a brief overview of the Mountain View, California-based technology giant, its core areas of business, and most important for prospective investors, the pros and cons that can help answer the question: “Should I buy Alphabet stock?”
— Alphabet stock at a glance.
— Pros of buying.
— Cons of buying.
— The bottom line: Should you buy Alphabet stock?
Alphabet Stock at a Glance
Alphabet is now a holding company that manages a variety of businesses. There are three main pillars of its ongoing success: its search and advertising business, its Android ecosystem, and the cloud. Despite the switch to the Alphabet corporate name, the firm’s success still stems from its core Google-branded products.
Since its beginning, Google built its reputation on its superior search engine. Google turned 23 years old in September, and after all that time, it remains the near-monopoly search engine in most markets except China. Old rivals such as Yahoo have long since faded from the arena. Google also flawlessly handled the switch from desktop to mobile browsing.
By building out the Android operating system, Google ensured that it would hold a strong position in the mobile advertising market. Apple Inc. ( AAPL) offers healthy competition to Android on the smartphone operating system front. However, since Android is open source, it has reached far broader adoption, especially in more cost-sensitive international markets. Alphabet has also fortified its moat in advertising by adding key properties such as YouTube to augment its core business. Google and Facebook Inc. ( FB) combined control more than half the online advertising market, giving them a privileged position in terms of setting prices and negotiating terms with clients.
Another key component of Alphabet’s business is its cloud computing operations. As of last quarter’s reported results, the Google Cloud business has now topped $18 billion in annualized revenues. Alphabet as a whole has surpassed $200 billion in annual revenues, so cloud isn’t actually a major chunk of the whole pie yet. However, the Cloud business is growing at a sizzling 54% annual rate. That even edges out the growth rate at key rival Microsoft Corp.’s ( MSFT) Azure cloud unit.
Shareholders are also willing to put a high valuation multiple on cloud earnings since cloud computing has wonderful growth prospects and profit margins. While the advertising business continues to be Alphabet’s cash cow, the cloud business is rapidly emerging as a star in its own right.
Pros to Buying GOOG Stock
The simplest argument for Alphabet stock is based on its valuation. Shares are trading at 30 times estimated 2021 earnings. That drops to 27 times for next year and 23 times estimated 2023 earnings. Overall, the S&P 500 trades at an estimated 22 times forward earnings. This means that investors don’t have to pay much of a premium to the market average to buy Alphabet stock.
However, Alphabet is probably deserving of a significantly higher price-earnings ratio than the market. After all, over the past decade, Alphabet has grown revenues at 20% per year and earnings 16% per year compounded. Those are incredible results for a company that is already as enormous as Alphabet. Usually, companies slow down once they become large, but Alphabet has resisted that tendency so far. Adding to that, analysts see the firm’s top-line growth continuing at 15% annually through at least 2023. Don’t forget that a good chunk of that expansion is coming from the cloud business that investors simply love right now.
With the valuation where it is, bulls argue that Alphabet’s other ventures, such as the self-driving-vehicles division Waymo, essentially serve as a cheap call option on technological innovation. With Alphabet’s core earnings being so strong, anything else the team’s engineers and research and development department comes up with is icing on the cake.
Cons to Buying GOOG Stock
One big risk for Alphabet is falling profit margins in the cloud business. Right now, cloud is exceptionally in demand and vendors like GOOG can essentially name their price and still find clients. Cloud’s boosters can rightly point to certain factors, such as lock-in of a customer’s data, in making cloud services sticky and high-margin. Still, there is a reasonable bearish argument that cloud hosting will eventually become a commodity service. Over time, services such as landline telephones, mobile telephones, cable TV and now broadband internet went from high-margin products to boring and much less profitable commodity businesses. Bears argue that cloud computing will eventually become just another utility offering.
Another considerable risk to Alphabet is its uncertain capital allocation strategy. The firm has famously made a ton of side bets that are only loosely related to its core search and advertising business. Google has taken on projects such as green energy, health care, delivery drones, robots and self-driving vehicles. Some of these, such as Waymo, still appear to hold incredible promise. Many, however, have failed to work out as the company hoped. Google has pulled the plug on a number of these efforts, and it’s far from clear that this scattershot approach of “moonshot” ventures has delivered much tangible shareholder value. If Alphabet had simply bought back stock or paid a dividend with those investment dollars instead, shareholders may have ended up much better off.
Alphabet’s defenders can use Apple as a counterargument. Apple has not innovated all that much since Steve Jobs’ passing and has arguably allowed itself to fall behind the Big Tech competition on a number of fronts. Aside from AirPods, Apple’s new product launches haven’t really turned many heads as of late. Allowing Amazon.com Inc.’s ( AMZN) Alexa and Google’s Nest to beat Apple in the smart home audio speaker market was particularly galling, given Apple’s historical excellence in consumer hardware products. So there is reason to encourage Alphabet to remain nimble. Alphabet doesn’t want to rely primarily on its advertising business forever.
Still, Alphabet’s other ventures have consumed a ton of capital and management energy with relatively little to show for them.
The Bottom Line: Should You Buy Alphabet Stock?
Alphabet shares are up more than 80% over the past 12 months. A lot of investors are going to pass on GOOG and GOOGL stock simply because it has gone up so much recently. That’s understandable. Shares are overbought on a short-term basis and haven’t seen a serious correction since March 2020. It wouldn’t be at all shocking if profit-takers cash in some gains on Alphabet stock over the next few months.
However, even at this price, Alphabet could still be a rewarding investment. On a valuation basis, it’s not selling for that much more than that the S&P 500 as a whole. Meanwhile, Alphabet has much more attractive growth prospects than the median company in the index. The cloud business in particular is on fire right now, and the other ventures such as Waymo could unlock substantial shareholder value over the next few years.
Meanwhile, there’s little sign of any meaningful decay in the core search and advertising businesses. The fact that regulators are so keen on trying to slow down Alphabet speaks to how influential the company is. With digital advertising booming alongside the economic recovery, Alphabet is well-positioned for the holiday season, and has sanguine prospects heading into 2022.
Even after its recent rally, Alphabet shares are worth buying if you’re a patient, long-term investor.
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