I love growth stocks as much as the next guy, but Alphabet Inc (NASDAQ:GOOGL) might just be my favorite at the moment. That’s because GOOGL stock has something that a lot of other high-growth dynamos simply don’t have:
Any value left whatsoever.
I’m prudent when it comes to hyper-growth stocks such as Amazon.com, Inc. (NASDAQ:AMZN) and Netflix, Inc. (NASDAQ:NFLX). I’ve missed out on some great runs as a result, but I also haven’t gotten burned when growth flags. Instead, I prefer to focus on “growth at a reasonable price,” or GARP — and I believe GOOGL stock falls into this category.
Go With GARP
With growth stocks, I look for a price-to-earnings ratio of a stock that is no more than 2x its earnings growth rate, if earnings are growing at 15% annually or more. And I want to back out stock buyback effects. To me, a GARP stock has a PEG ratio of 1.0, though I’ll allow up to 1.5 depending on the earnings growth rate.
GOOGL stock trades at 29x FY16 earnings and about 21x FY17 earnings. Analysts see five-year annualized growth at 19.2%. So on the surface, Alphabet seems to qualify as a GARP pick.
But there’s even more good news.
This doesn’t consider the net cash position of GOOGL stock. See, I value a company net of its net cash hoard, just as Peter Lynch used to do. With $86.4 billion on its balance sheet, that pulls the market cap for Alphabet down to about $480 billion.
On $19.5 billion in net income for FY16, we suddenly find that Alphabet stock trades at 24.6 times FY16 earnings and only about 17.5 times FY17 earnings.
That’s the first step for me in even determining if GOOGL stock is a stock to get involved in.
How Is Alphabet’s Business?
The next thing I examine is how healthy Alphabet Inc’s actual businesses are.
I still don’t like the idea that GOOGL is basically a giant digital advertising billboard with a venture capital arm. However, I can’t deny that Google’s search engine holds an astonishing 80.47% market share. As long as four out of every five searches are conducted on Google, advertisers will throw money at Alphabet. There would have to be a scandal of monumental proportions, or some incredibly innovative new method of searching, to change this significantly.
Alphabet’s 17% year-over-year increase in advertising revenue to $22.4 billion comes as no surprise.
So next I look at the YOY metrics, which look fantastic Aggregate paid clicks up 36%, paid clicks on Google properties up 43%, and paid clicks on Network properties up 7%. A lot of people freaked out that cost-per-click fell 15%, 16% and 19% for each of the above categories, respectively. The market doesn’t seem to realize that this is because more advertising is being pushed to mobile.
As for Other Bets, which is basically the company’s VC arm, I don’t love that it blew a billion dollars in the quarter. But considering free cash flow was $6.33 billion, and net cash is $86.4 billion, GOOGL has that money to spend. With portfolio strategy, all it takes is one of these VC bets to hit, and all that money spent will be made back and more.
This brief glance tells me that Alphabet is an advertising business with dominant market share that is literally printing money. I mean, it generated $26 billion in free cash flow in FY16. That’s free cash flow, meaning it can do whatever it wants with it.
That’s even after spending about $10 billion in capex.
Bottom Line on GOOGL Stock
Normally, I would continue to examine other parts of the business if I were looking to include GOOGLin something like my forthcoming stock advisory newsletter, The Liberty Portfolio.
But for right now, I see enough to suggest investors continue their own due diligence and strongly consider GOOGL stock as a GARP play.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.