The Key to Alphabet Inc (GOOGL) Stock Isn’t What You Think

It wasn’t a good year for Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) in 2016. Sure, it generated $17.1 billion in operating income through the first nine months of its current fiscal year on $64.2 billion in revenue, but at the end of the day GOOGL stock only managed a total return for shareholders of 1.9%.

The Key to Alphabet Inc (GOOGL) Stock Isn't What You Think

That’s on par with its internet content peers, but way off the 12% delivered by the S&P 500. Not good by Google standards.

Holding GOOGL stock back — a bit of a misnomer considering that it has nearly doubled the return of the S&P 500 over the past five years — is a valuation that InvestorPlace contributor Dana Blankenhorn feels is “priced to near-perfection” with a price-earnings ratio of 29 based on a consensus per-share earnings estimate of $26.90 in 2016, $32.25 in 2017 and $36.99 in 2018.

So, analysts expect Alphabet to grow earnings by 17.3% annually over the next two years — that’s a two-year PEG ratio of 1.7. By comparison, Facebook Inc (NASDAQ:FB) has a two-year PEG ratio of 1.6 based on annual EPS growth of 29%.

From this perspective, GOOGL stock doesn’t look too bad; you have to conclude that either FB is overvalued at this point or GOOGL isn’t quite as expensive as people think.

Especially when you consider that there’s still gas in Alphabet’s tank.

Google Travel Is Fueling GOOGL

Leading the charge is its travel business which has quietly become a key element in Alphabet’s success. As the travel vertical prospers, so too does Google and its parent.

According to Dennis Schaal of Skift, Google’s travel business will generate an estimated $12.2 billion in advertising revenue in 2016, accounting for 13.7% of Alphabet’s projected 2016 revenue of $89.3 billion. Put another way, Google’s travel business will generate approximately 1,670% [calculation: $12.2/4 multiplied by 3 divided by Other Bets Q1-Q32016 revenue of $547 million] more revenue in 2016 than its Other Bets segment, which includes much of the innovative work being done by the company, including Nest, Fiber, etc.

On its own, Google Travel would be a pretty large company with operating profits of $3.8 billion. While advertising might be boring, one can’t underestimate the importance of this vertical to the company’s profitable growth.

And you can forget about Google becoming an online travel agency with this much money on the line. It’s not going to cut off its nose to spite the face. It’s just not.

“Google’s existing revenue from travel advertisers is already considerably larger than that of the Priceline Group Inc (NASDAQ:PCLN); is roughly twice the size of Expedia Inc’s (NASDAQ:EXPE), and Google generates more travel advertising revenue than that of Expedia, Ctrip (NASDAQ:CTRP) and TripAdvisor Inc (NASDAQ:TRIP) combined,” wrote Schaal in his November 2016 article on the subject. “Google undoubtedly takes that travel-advertising revenue and achieves a much higher profit margin on it than do the roster of its online travel, airline, hotel, car rental and cruise partners.”

Yes, it’s true that Google maintains an uneasy relationship with its advertiser partners, a relationship they sometimes resent, but until they can successfully build a workable alternative, they’ll need Google more than Google needs them.

Now consider what the company’s doing on the venture capital front. In September, CapitalG (formerly Google Capital) led a late-stage $850 million round of financing of Airbnb that values the private company at $30 billion. Some of the funds raised by the home-sharing service will be used to set up its own flight booking service to compete with some of Google’s bigger advertising partners (Priceline, Expedia) in that very competitive segment of the online travel business.

While Airbnb currently spends about $300 million in advertising with Google on an annual basis, you can expect that number to increase once Airbnb gets its second stream of revenue online sometime in 2017.

Utilizing CapitalG to fund opportunities within the travel space that don’t put them directly in competition with their advertisers is the key to future success for both the travel vertical and Alphabet itself.

I like GOOGL stock for a lot of different reasons, but its travel business is certainly one of them.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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