When it comes to Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) and Amazon.com, Inc. (NASDAQ:AMZN), there are a number of similarities. Both companies are tech titans. Amazon stock has the second-highest market cap in the world; GOOGL stock is third.
But there are a number of differences as well. The most obvious is in terms of valuation. Indeed, the choice now appears to be growth versus value.
AMZN is a classic growth stock — maybe the ultimate growth stock. It still trades at 85x forward earnings, an incredible valuation for a company that is coming up on the 24th anniversary of its founding. In contrast, GOOGL stock looks downright cheap, at 24x 2019 consensus EPS, and closer to 22x when backing out the company’s cash hoard.
AMZN’s incredible run — the stock is up almost 75% just since late November and has added over $350 billion in market value over that stretch — has only added to valuation concerns. Meanwhile, Alphabet has performed well and so far disproved a number of the concerns held by skeptics like myself.
For now, I still give a slight edge to AMZN in the “Google versus Amazon” debate. But in this market, I’ll admit that investors could choose GOOGL — or at these levels, perhaps neither.
What’s interesting about the two stocks is the valuation gap seems close to ridiculous given roughly similar growth profiles of late. In 2017, Amazon.com grew revenue an impressive 31%. Alphabet sales rose 22.8% year-over-year.
But if you exclude the acquisition of Whole Foods Market, the companies’ top-line performance looks almost identical. Pro forma figures from the Amazon 10-K suggest sales grew 23.1% — just three-tenths of a percentage point faster than Alphabet. And while Alphabet’s operating income rose 10% in 2017, Amazon’s actually declined 2%.
From a purely fundamental standpoint, then, Alphabet seems to have a huge advantage. It’s growing revenue essentially as fast as Amazon is, at least on an organic basis. Yet its forward earnings multiple, excluding its cash, is one-fourth that of its rival. But there are reasons why the gap makes some sense.
One of the biggest reasons is the respective companies’ advertising business. For Alphabet, advertising is the business. Over 86% of 2017 revenue came from advertising, per the 10-K.
The company’s “Other Bets” segment has some interesting businesses, including self-driving car unit Waymo, valued by one estimate at some $70 billion. But even that impressive figure is less than one-tenth of Alphabet’s market capitalization.
And it’s the advertising business that causes concern. Cost per click continues to rise, raising fears of margin compression. The move to apps — both in terms of mobile and in the Windows 10 operating system — raises the risk of lower search demand.
Meanwhile, advertisers continue to question ad placement at YouTube in particular, with Cisco Systems, Inc. (NASDAQ:CSCO) joining Procter & Gamble Co (NYSE:PG) and Unilever N.V. (NYSE:UL) in pausing or pulling back on spend on that platform.
Amazon, in contrast, has a tiny advertising business — at least for now. But it has a real opportunity to challenge Google and Facebook, Inc. (NASDAQ:FB) in that space.
Adding video advertising could contribute billions of dollars in revenue at huge margins. And because of Amazon’s huge reach among shoppers and its vast trove of purchase-intent data, its ad business would seemingly face far less risk.
One interesting commonality in the Google versus Amazon debate is that both companies have struggled notably in the hardware space. Amazon’s Fire Phone was one of the company’s biggest misfires.
Google similarly struggled with its Pixel, and even the Nest unit appears to have been a disappointment so far. Its deal with HTC doesn’t appear to solve Alphabet’s long-running weakness in the space. And neither company has proven to be a worthwhile competitor to Apple Inc. (NASDAQ:AAPL), particularly in smartphones.
Bottom Line: Google Versus Amazon
When it comes to choosing between AMZN stock and GOOGL stock, investor preference likely is a big factor. Value investors might see Alphabet’s cash hoard, earnings growth, and multiple as far more attractive than Amazon’s market share and huge valuation. (Indeed, as bullish as I’ve been on AMZN, at this point, I struggle to see much more upside.)
But the long-term success — or struggles — of both stocks likely is going to come down to margins. For Amazon, the bull case is that margins will expand at some point once the company is done investing.
That expansion could come through price hikes, like the recent increase in Prime subscription fees. Amazon could pull back on some of its current money-losing efforts. Or it could find new areas to monetize, like advertising.
However it works, the bull case for AMZN stock is that margins are artificially low right now, and thus investors can’t just focus on 2019 earnings or write the stock off due to high headline P/E multiples.
For GOOGL stock, the argument is reversed. The fear about Alphabet is that its margins are at or near a peak. If search demand drops and acquisition costs don’t, margins (which did compress modestly in 2017) will come down. Profit growth will slow, if not reverse, at some point, and even a low-20s multiple will prove too high.
The bull case is that Alphabet’s immense amount of data, increasing capabilities in AI, and (possibly) success in “Other Bets” like Waymo, Verily and Nest will be more than enough to overcome any ad weakness, should it arrive. As such, the margin worries facing GOOGL stock are just as short-term as those facing AMZN, albeit in a very different way.
Forced to choose at this point, I’d still pick AMZN because it’s easier (and wiser) to own a business with potential for margin expansion as opposed to one simply trying to protect its existing structure. But at this point, I’ll also admit the Google versus Amazon debate might be too close to call and that other investors could see the situation very differently.
As of this writing, Vince Martin has no positions in any securities mentioned.