After getting a mouthful of Alphabet Inc (GOOG, GOOGL) earnings Monday evening, two remnants of the report are left bobbing at the surface of investors’ collective consciousness.
The first: We finally got a look at how much GOOGL spends on non-advertising ventures. Google Fiber, Calico, Nest, Verily, Google Ventures, Google Capital and Google X managed to actually generate $448 million in revenue … for a loss of $3.57 billion.
Only Google could survive a segment that literally lost billions.
The second: Every other headline is screaming about how Alphabet surpassed Apple (AAPL) as the world’s most valuable company, at $552 billion. I could care less. I just want to know how its price relates to its earnings.
But let’s address the first question and delve into the numbers.
Alphabet by the Numbers
For the quarter, Alphabet revenues increased 18% YoY to $21.33 billion, and up 24% in constant currency. Alphabet operating income soared 22% to $5.38 billion.
Margins were insanely good. Alphabet revenue for the year was $74.54 billion and operating profit was $23.43 billion. Alphabet operating cash flow was stellar at $6.42 billion while free cash flow came in at $4.32 billion.
The balance sheet is ridiculously good, with $73.1 billion of cash and investments and only $3.2 billion in debt.
That’s around $120 per share in net cash.
There are also plenty of great metrics. More and more people are clicking on ads and the cost of each click is falling. There was a 31% YoY increase in clicking and a 13% decline in cost, while aggregate paid clicks rose 17% sequentially and paid clicks on Google websites were up 22% sequentially and 40% YoY.
So it leads to the question of whether any of Google’s current or future ventures will actually make money. The thing about venture capital is that if one out of twenty concepts hit, you’ll make money in the long run. Yet, this is the only other thing GOOGL has going on; so if none of them hit, it remains nothing more than a search advertising business.
Investors first need to determine if that’s a business they want to own. Advertising is highly subject to economic conditions. If we hit a recession, ad spending will decline, and so will Alphabet earnings. That’s not to be taken lightly, because as we saw in the financial crisis, a 15% decline would translate to a big revenue hit and at least 15% downside to GOOGL stock.
Valuing GOOGL Stock
With Alphabet trading at around $800, backing out the $120 in cash per share puts the business at $680 per share for a market capitalization of $470 billion. On net income of $6.04 billion, that gives it a price-earnings ratio of roughly 78.
I’m cringing, but let’s see if that’s truly unreasonable. Net income grew from $4.65 billion, so the increase was 30%. That’s pretty darn impressive. I give GOOGL a 10% premium for its cash on hand, free cash flow and brand name, which would lift the nominal fair value to 40.
With high-growth stocks, I’m willing to pay a price-earnings growth ratio of 2, so in fact, that lands us right on today’s stock price.
What investors are left with, then, is whether or not to bet on this high-flying growth stock that is not unreasonably valued. I have concerns at these levels, not just because of the recession possibility, but because we are in a bear market.
I think the move for now is to wait for a lower entry point, or sell naked puts several months out.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
