Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) is chugging along rather nicely, and it is shaping up as a necessary core holding in a long-term diversified portfolio. However, I’m not completely convinced yet, because its revenue streams aren’t yet diversified enough. Today, GOOGL is fairly valued and worth looking into as a buy … here, I’ll explain why and why I also think you should wait for lower prices.
We know all about the advertising business that makes up the backbone of Google.
In its entirety, GOOGL generated $21.5 billion in revenue in Q2, which was a mammoth increase of 21% (after currency effects). Operating income was $5.97 billion, up 28%, with net income coming in at $4.877 billion.
Why is this important? Because, while Alphabet Inc is pretty much a massive digital billboard company, it’s one that is making its users very happy. To me, it is flat-out amazing that revenues are up 21%. It says that GOOGL has unquestionably become one of the dominant advertising brands in the world.
Things to Consider Before Buying GOOGL
It is also significant because the business runs so efficiently that it generated $7 billion in free cash flow in that quarter alone. That allows GOOGL to fund its unfortunately named “Other Bets” division. I don’t like the word “bets” because it generates images of a casino, rather than the more thoughtful approach of “venture capital”.
Google Fiber, Calico, Nest, Verily, Google Ventures, Google Capital and Google X did deliver $185 million in revenue, so these efforts are generating small returns. And they did lead to an operating loss of $859 million; however, that amount of free cash flow means Alphabet Inc can afford to play this game. One hit could mean tremendous amount of profit.
Meanwhile, GOOGL stock banks most of the rest of that cash, and its cash balance is now $78.5 billion. So even if these Other Bets fail, Alphabet Inc could always go out and acquire as many companies as it wanted to diversify its profit stream.
With about 700 million shares outstanding, GOOGL stock thus carries about $110 per share in cash.
So, what is Alphabet Inc. worth and why do I think you can get it cheaper?
With GOOGL stock trading at about $684, accounting for the $110 in cash per share, the market cap thus becomes $470 billion. On trailing-12-months net income of $18 billion, Alphabet Inc stock is thus trading for 25x earnings. With net income rising at a rate of 28%, that is not only a value stock, but a growth at a reasonable price stock. To me, a stock is a growth stock if it grows earnings-per-share at 15% or greater. If its price/earnings-to-growth ratio comes in under 1.0, then it’s a GARP stock.
You could buy GOOGL stock here and hold it for the very long-term, and I bet you’ll be very happy.
However, I also believe you will be able to get Alphabet Inc stock cheaper. Right now, the overall market is insanely overpriced. The S&P 500 is trading at about 25x earnings, while the long-term mean has been about 16. I think we are headed for a market correction, and I think that means you could get GOOGL for between $650 and $720 per share (before backing out cash).
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
