Why You Should Stick With Alphabet Inc Stock for the Long Term

GOOGL stock is way too cheap to consider selling any time soon

By Luke Lango, InvestorPlace Contributor

The EU's $5B Ruling Won't Trip Up Google Stock

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With hyper-growth tech stocks showing some signs of weakness recently, Mad Money host Jim Cramer took a deep-dive into the bear thesis for each of the major tech stocks.

Amazon.com, Inc. (NASDAQ:AMZN) is facing stiffer competition from Wal-Mart Stores Inc (NYSE:WMT). Apple Inc. (NASDAQ:AAPL) may have already reaped the rewards of its iPhone “super-cycle.” Netflix, Inc. (NASDAQ:NFLX) is at risk to bigger competition from Walt Disney Co (NYSE:DIS).

But Cramer struggled to come up with a bear thesis for Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL), and that’s because there really isn’t any reason to sell GOOGL stock at these levels.

Revenue growth is big and consistently in the 20%-plus range. Margins aren’t booming higher, but they are expanding and driving robust profit growth.

The big driver of this growth (digital advertising) is showing no signs of slowing down in any worrisome way, while big drivers of future growth (Waymo, Google Home and Google Cloud) are starting to ramp up. The valuation is very reasonable. Competition isn’t coming up in any major way.

Overall, there really isn’t a strong bear thesis to patch together against GOOGL stock. But there is a strong bull thesis.

Why GOOGL Stock Is Extremely Undervalued

From a valuation standpoint, here is how I look at GOOGL stock.

GOOGL’s revenue growth was 20% last year, and it will be above 20% this year. In other words, revenue growth isn’t slowing down in any meaningful way.

There is still a bunch of advertising dollars that have yet to shift from traditional mediums to the digital channel, implying that growth in Google’s core advertising business will remain big.

Growth is expected to slow somewhat (eMarketer projects Google’s digital advertising revenue growth slipping from 19% in 2017 to 14% in 2019). But that compression will be partially offset by a growth ramp in Google’s other businesses.

Smart home-tech adoption will only accelerate over the next several years. Google is a leader in that market. Autonomous driving is coming, and Google’s Waymo is the leader. Hyper-scale data centers are still in their relative infancy considering the recent explosion in data. Google runs one of the biggest and fastest-growing cloud businesses in the world.

Growth in those businesses will help offset decelerating growth in Google’s core advertising business over the next several years. But because Google’s advertising business is so large, overall growth rates will come down. In total, I expect revenue growth to go from 20% today to about 15% over the next several years.

Margins aren’t expanding in a big way, but they are expanding some. Considering mobile search carries higher acquisition costs and lower cost per click than desktop, and that mobile is the future, GOOGL really isn’t a margin expansion story. Moreover, management is focused on margin dollar growth, not margin rate growth, so it’s likely that margins only inch up over the next several years.

Roughly 15% revenue growth, slight margin expansion, and buybacks should drive at least 20% earnings growth over the next several years (for what it’s worth, the Street is modeling for 22.6% growth).

GOOGL stock is trading at just 33.3x this year’s earnings estimate. That means the stock is trading at a 67% premium to its 20% growth prospects (or a 50% premium if you use the Street’s 22.6% earnings growth rate).

But the S&P 500 is trading at a near 100% growth premium despite materially lower growth prospects (20.5x earnings for 10.5% growth).

In other words, GOOGL stock is trading at a huge discount to the market after considering growth. And that makes no sense. GOOGL has $100 billion in cash on the balance sheet against very little debt. Tax reform will provide a boost to earnings. Many of Google’s growth drivers have long runways. Profit margins are healthy.

Consequently, at these levels, GOOGL stock is just materially undervalued.

Bottom Line on GOOGL Stock

There really isn’t a good reason to sell GOOGL stock. It’s materially undervalued and positioned for huge growth over the next several years.

That is a promising combination for healthy share price appreciation in a long-term window.

As of this writing, Luke Lango was long GOOG, AMZN, NFLX and DIS.

Article printed from InvestorPlace Media, https://investorplace.com/2017/12/why-you-should-stick-with-alphabet-stock-long-term/.

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