Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) stock is up more than 18% year-to-date to sit around $940 at the moment. That would seem a strong performance, especially given that GOOGL stock has more than doubled the S&P 500’s returns this year.
However, it’s bittersweet considering Alphabet had passed $1,000 earlier this year before the June 9 Goldman Sachs hit that knocked down the likes of GOOGL, Amazon.com, Inc. (NASDAQ:AMZN), Facebook Inc (NASDAQ:FB) and Microsoft Corporation (NASDAQ:MSFT).
Alphabet stock was further knocked down a few weeks ago after a downgrade by analysts at Canaccord Equity, who cited an expensive price/earnings multiple.
There’s no shortage of bears, in fact. InvestorPlace contributor Laura Hoy considers the stock a sell, and James Brumley thinks the company will face more competition for ad revenue.
Alphabet is suing Uber for supposedly stealing trade secrets relating to self-driving car technology from its Waymo division. It also faces multiple antitrust cases in the European Union. So the legal side of things makes GOOGL stock a more complicated decision than it has been in the past.
Is Alphabet to be avoided right now, then, or is it still as strong a buy as it has been for years?
GOOGL Stock Pros
Valuation: The Nasdaq is up more than 14% year-to-date, and while it recently has lost a little froth, there’s still a legitimate worry that tech stocks are too expensive.
I view this as a valid concern, but not all tech stocks are exposed to the same level of risk. Snap Inc (NYSE:SNAP) is a very young company with negative cash flow that has never generated a profit, and still trades at 39 times sales. A shock to the markets would probably hurt Snap more than Alphabet, which generates positive cash flow, has little debt and billions in cash to sustain it during a downturn.
If you wish to invest, you should look for stocks trading at lower valuations. Among tech companies, Alphabet looks like a value stock. GOOGL stock changes hands for an enterprise value-to free cash flow multiple of 20.25, lower than Amazon (47.72), Facebook (31.53) and Alibaba Group Holding Ltd (NYSE:BABA, 30.50).
Strong Financials: Alphabet has a strong financial foundation. In the three months ended March 31, 2017, the firm held $92.46 billion in cash and short-term investments, and only $3.94 billion in debt. Since Alphabet generates about $7 billion in free cash flow every quarter, it won’t have to worry about a cash crunch, unlike other tech companies.
Alphabet funds itself via retained earnings, having reinvested $109.42 billion in profits back into the business over the years.
Alphabet also has a very high Altman Z-Score, which measures bankruptcy risk.
This cash position should come in handy in the event of a downturn. Other tech companies may find themselves in financial distress, allowing Alphabet to buy stakes in them at depressed prices.
Side Projects: Buying GOOGL stock is perhaps the closest that retail investors like me can get to investing in a venture capital firm. When other companies were mired in short-termism, Alphabet invested in long-term “moonshot” projects through its “X” division. One of these became Waymo, the self-driving car project.
This includes Calico, a biotech venture with Arthur Levinson, the former CEO and Chairman of Genentech, at the helm. Calico hopes to extend the human lifespan, and has hired the distinguished biologist Cynthia Kenyon as head of aging research. Calico is also working with a biotech company on cancer drugs.
Alphabet has another biotech division, Verily Life Sciences. It also owns the artificial intelligence company DeepMind. As I mentioned in my article on AT&T Inc. (NYSE:T), Alphabet also provides high-speed internet to various cities through Google Fiber and to remote locations via Project Loon.
And that’s not all. Alphabet has two venture capital arms: one named CapitalG (formerly Google Capital), and another called GV (formerly Google Ventures).
You can get exposure to self-driving car technology at a lower valuation than some of its competitors in the space, including Tesla Inc (NASDAQ:TSLA) and Nvidia Corporation (NASDAQ:NVDA).
GOOGL Stock Cons
Dependence on Ad Revenue: Investors are told that they can reduce risk by diversifying their assets and not putting all their eggs in one basket. A company making everything from action movies to toothpaste and fighter jets might be impractical and difficult to manage, but to a certain extent the same principle applies: you don’t want to be too dependent on one revenue stream.
We live in an age of digital disruption, where existing business models can be overturned within a few months.
Alphabet depends heavily on advertising, which accounted for 86.5% of total revenue in the three months ending March 31, 2017, down from 88.96% the year before. But Alphabet is hardly alone in this regard.
Really, Microsoft stands as the only truly diversified tech giant.
Tough Competitors: Fast-growing, high-margin industries tend to attract new entrants, and Alphabet faces some tough competitors in the industries it operates in.
In cloud computing, Alphabet competes with Amazon Web Services, Microsoft’s Azure, IBM, and Alibaba’s AliCloud. The Google Home speaker is up against Amazon’s Echo and Apple’s HomePod.
Alphabet’s Waymo division is not alone in the race to develop self-driving car technology. Here it faces Uber and Tesla; Apple; Chinese tech giants like Baidu Inc (ADR) (NASDAQ:BIDU) and Alibaba, and also traditional automakers like Ford Motor Company (NYSE:F).
Admittedly, Google dwarfs other search engines in terms of market share for both desktop and mobile.
But cracks might be emerging as Alibaba develops new mobile operating systems like YunOS and new browsers like UCWeb and puts them on low-priced Chinese smartphones, which are selling well in the developing world. Alibaba’s UCWeb commands a greater market share among mobile browsers than Google Chrome in India. Baidu also sees India as a growth market.
Alphabet also faces competition from Amazon in product search.
Antitrust Concerns: Alphabet now faces not one, not two, but three antitrust cases in the EU, and these could put a dent in its profits.
One suit involves the Android mobile operating system; the company reportedly forced smartphone makers to load 11 Google apps into the phone and to set Google as the default search engine.
Another case involves GOOGL’s comparison shopping service, which it supposedly set up to favor Google Shopping. Sources said earlier this month that the EU plans to announce the fine before summer break in August. This case carries a fine potentially as high as €1 billion.
Alphabet faces another antitrust suit in the EU over its AdSense platform.
There also were concerns over the Trump administration bringing forth antitrust suits, although these appear to have receded. However, Alphabet isn’t the first tech company to face scrutiny from EU regulators over antitrust concerns.
The Verdict
In previous articles I’ve expressed my concerns over the broad market and its valuation. The stock market appears expensive by multiple measures, including median price/sales, Tobin’s Q, the Shiller P/E ratio, and EV/EBITDA.
I’m something of a contrarian, and think there might be more upside in things like silver and farmland.
That said, Alphabet’s long-term growth prospects remain solid, and it looks better than many of its peers. This rally could continue for a few more years, so selling out now might not be a good idea, particularly for investors with longer time horizons.
But I wouldn’t load up on GOOGL stock, either. At 31 times earnings and 23 times forward earnings, it doesn’t look too cheap; just because some other companies are trading at even higher valuations isn’t a good enough excuse.
And Alphabet looks more expensive when you look at its cyclically adjusted price/earnings ratio.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.
