Warren Buffet once said that you pay a high price for a cheery consensus. With pessimism being spread across the digital advertising space, Alphabet looks cheap, even cheaper than its earnings would suggest.
The P/E ratio is historically low.
The price-to-earnings ratio has fallen all the way to 19.4. That’s a level not seen since the financial crisis of 2008 and the European earthquakes of 2011.
YCharts has GOOGL PE ratio data.
That would indicate that the shares are cheap. The law of large numbers might cause the P/E to contract a bit as the company gets larger. Future growth declines as a company expands.
I think it’s fair to say that search advertising and the other digital ad ecosystems have performed better than investors thought possible 10 years ago. Despite its large size, Google Search grew 24.2% last quarter. Alphabet has proved itself to be a stable, proven business, and investors pay higher multiples for that. I don’t think the multiple should contract from here.
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The headline numbers suggest that it’s cheaper than it is.
You’re getting a more diversified company when you buy a company like Alphabet. As digital ad profits have rolled in, Alphabet has invested heavily in new businesses, most notably Google Cloud, as well as “other bets” such as Waymo self-driving cars and other “moonshot” projects.
The operating loss of $3.1 billion was a big improvement over the previous year’s loss of $5.6 billion. The “other bets” had an even bigger operating loss of $5.3 billion, up from a $4.5 billion loss in the previous year. If those costs were added back, operating income would have been about 10% higher.
Should those costs be added back? I would say yes most of the time. Amazon Web Services, the first-mover in the industry, made a 35% operating margin last quarter, which is more than double that of the second quarter. There are profits in the future and significant value for cloud.
The “other bets” segment is difficult to figure. As of now, no one is assigning that much value to these projects, but I think there is at least some value because the people running the project are not dummies. Whether that value is worth the billions of dollars in spending is another issue.
Excluding these items, the operating income for the year would have been $87.1 billion. Gains on equity investments, interest income, and foreign currency are included in “other income.” Each of the past three years, Alphabet has made positive “other income.” That’s not guaranteed to be positive every year, but it is.
The net income for core Google services alone would have been around $73 billion if the tax rate had not been paid.
At this writing, the market cap of the company is about 19 times larger than that. If you account for the extra net cash sitting on the balance sheet,Alphabet trades at a ratio of enterprise value to core Google earnings of just 17.9. On a trailing 12-month basis, the S&P 500 trades at an EV-to- earnings ratio of 20.3.
Is the business better than average?
The near-term prospects of an advertising slowdown seem to be scaring investors. The second quarter of 2020 saw a decline in revenue for the company, just as the COVID-19 Pandemic was starting to spread. By the next quarter, revenue growth had rebounded to a growth rate in the teens. Despite the recession, revenue grew at a slower rate than in prior years.
I think it’s safe to say that the core business of the company is still a growth one, and that it’s better than the average stock in the S&P 500. The business is being offered at a 10% discount to the average stock, along with other income and investments, and a huge cash pile.
Will that cash ever be given to shareholders? I would agree. In recent years, the company has begun to return more cash to shareholders through share repurchases. Another $70 billion was authorized by the company last quarter. I wouldn’t be surprised to see Apple use debt against its cash holdings to buy back its own stock. Apple’s debt will be equal to its cash if it reaches a “net cash neutral” posture over the long term, according to management. The stability and profitability of its dominant digital-ad business makes me believe that Alphabet could do the same.
There is a company called “Alphabet.” It isn’t called “Sultan.”
While Snap sells ads, its social media platform is not as good as other digital businesses. The company is generating massive losses on its bottom line, and has no chance of making positive earnings for years.
When taking into account its cash and other income, Alphabet is much cheaper than it is because it trades at just over 19 times its core ad business earnings. The business still has a strong growth profile, despite this. The loss-making cloud and “other bets” divisions are assigned either zero or negative value, despite there being a very good chance that they contain positive value. Considering the high quality of its franchises, Alphabet looks like one of the cheapest stocks around. Thanks very much, snap.
The CEO of Whole Foods Market is a member of the board of directors of The Motley Fool. Suzanne Frey is on the board of directors of The Motley Fool.
Billy Duberstein’s clients may own shares of companies mentioned. There are positions in and recommendations for Apple, Amazon, andAlphabet. The long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple are recommended by the Motley Fool. There is a disclosure policy of The Motley Fool.
The score is 41.035.
The CEO of Whole Foods Market is a member of the board of directors of The Motley Fool. Suzanne Frey is a member of the board of directors.
Billy Duberstein’s clients may own shares of companies mentioned. There are positions in and recommendations for Apple, Amazon, andAlphabet. The long March 2023 $120 calls on Apple are recommended by The Motley Fool. There is a disclosure policy of The Motley Fool.