In this article, I will outline three of the reasons why I hold a bullish position on Alphabet (NASDAQ:GOOGL) stock. These reasons are tailwinds in advertising spending, cloud potential, and the stock’s reasonable valuation.
Alphabet has performed relatively well in 2024, delivering nearly twice the return you would have received by investing in the S&P 500 Index (SPX). This performance aligns with the company’s growth expectations, particularly in its key markets, such as advertising, where AI innovations in Google Search are being incorporated.
Nonetheless, I believe that certain segments, such as the cloud, are overlooked by the market when assessing Alphabet’s future potential. This might be why the stock is traded at reasonably valued multiples compared to other major tech companies.
Poised to Benefit from Tailwinds in Advertising Spending
Alphabet currently holds the title of the most dominant advertising company globally, and the digital advertising sector is poised for significant growth in the years ahead.
According to projections, digital advertising spending worldwide is expected to surge from $679 billion in 2023 (with 40% specifically in search advertising) to $965 billion by 2028, representing a compound annual growth rate (CAGR) of approximately 7%. With Alphabet leading the pack in digital advertising, it stands to reap substantial benefits from this upward trajectory.
Digital advertising offers distinct advantages over traditional linear advertising. It enables more precise measurement of results and facilitates targeted advertising to specific audiences, rendering it a more appealing option with significantly higher returns from both business and marketing perspectives.
Google Search, with its commanding market share in the search engine sector, and YouTube, boasting over 2.7 billion monthly active users, are pivotal assets bolstering Alphabet’s competitive edge. The incorporation of generative AI features, such as products leveraging LLMs (large language models) to match ads to relevant searches, enables users to find answers to more complex queries and increases usage and satisfaction with the results.
Google Cloud Potential
According to Alphabet’s management, the Google Cloud segment and YouTube are anticipated to achieve a combined annual run rate of over $100 billion by 2024.
In pursuit of this goal, the company has committed to investing in infrastructure, especially servers, nearly doubling its capital expenditures to $12 billion in Q1 2024 compared to Q1 2023. Despite the Google Cloud segment operating at a loss in recent years due to reinvesting all profits into growth, Alphabet’s cloud computing business remains in a growth stage.
Although the segment reported an operating margin of 9% and generated $900 million in operating income in Q1 2024 (see below), this likely has not yet translated into free cash flow, in my opinion (Alphabet doesn’t disclose the segment’s free cash flow figures).
For comparison, Amazon’s (NASDAQ:AMZN) AWS boasts an operating margin of around 37%. As Alphabet strives to enhance the efficiency of Google Cloud through its investments, achieving margins akin to AWS could result in the company generating billions in annual operating income from this segment. This would represent a significant source of profit beyond its core search business.
A Fairly Priced Big Tech Stock
Despite a 26% increase in its stock price year-to-date, Alphabet maintains a relatively inexpensive valuation compared to its main big tech peers.
Considering a consensus that implies roughly 30% EPS growth for Alphabet this year, the stock trades at a forward price-to-earnings (P/E) multiple of 23x, which is the lowest among its “Magnificent 7” peers. This includes Meta Platforms (NASDAQ:META), which trades at 25x and is much more discounted than Tesla (NASDAQ:TSLA), the member of this group that’s trading at the highest multiple of 67x.
When considering cash flows, Alphabet’s price-to-cash flow (P/CF) ratio over the trailing 12 months stands at 20x, slightly above Amazon’s 19x and Meta’s 16x, based on its $2.19 trillion market cap. Despite this, I still find this valuation reasonably justified. Alphabet continues to invest significantly in growth opportunities, which should drive future expansion. However, these investments negatively impact short-term cash flows, resulting in a higher P/CF multiple.
Regardless, Alphabet has strong net profit margins (nearly 26%), an effective monopoly in its core search business, and a pristine balance sheet within an industry approaching a trillion dollars in value and continuing to grow. These factors would typically justify a higher valuation multiple, but that is not necessarily the case for Alphabet right now.
Is GOOGL Stock a Buy, According to Analysts?
Wall Street analysts are extremely bullish about the future of Alphabet stock, with the consensus rating being a Strong Buy, and 32 out of 37 analysts recommending buying GOOGL. The average GOOGL stock price target is $197.67, implying upside potential of 12.2%.
Among the bulls, Tigress Financial analyst Ivan Feinseth asserts that GOOGL deserves a Buy rating due to confidence in the company’s ability to enhance its products with generative AI technology. This enhancement is anticipated to significantly boost revenues, supported by the company’s ability to invest in key growth initiatives and strategic acquisitions, thanks to its strong balance sheet and healthy cash flows.
The Bottom Line
There are numerous reasons to maintain a bullish stance on Alphabet that extend beyond just three factors. Still, to reiterate, I firmly believe that the company’s dominant position and its ongoing investment efforts in search will yield significant returns as the industry continues to experience robust growth.
Furthermore, I find that other segments, such as cloud computing, are still undervalued by the market, and there is substantial potential for value creation as investments lead to even stronger cash flows in the future.
When considering these factors alongside the company’s attractive valuation compared to other big tech firms, I maintain a highly bullish position on Alphabet stock.
