Google stock (as many still call it), backing out roughly $150 per share in net cash, trades at under 22x 2019 consensus EPS estimates. And Alphabet earnings are somewhat tricky, as I detailed back in March.
Losses in the company’s “Other Bets”, including self-driving startup Waymo, provide a headwind. Gains in investments including Lyft (NASDAQ:LYFT) and Care.com (NYSE:CRCM) have provided a boost, though declines in LYFT stock since its IPO suggest a potential reversal in the third quarter. Fines from the European Commission have affected profits as well.
Still, however an investor chooses to adjust Google’s earnings, the end result is roughly the same: Google stock still looks cheap. The long-running question is whether it should be cheap. I’ve generally answered “yes” and on occasion, the market has agreed. With the Alphabet stock price again closer to its highs than its lows, the near-term question is whether GOOGL stock will become cheap again.
The Case Against Google Stock
The argument against GOOGL stock has been that the company is reliant on advertising revenue which may well peak. 88% of 2018 revenue came from advertising, according to the Alphabet 10-K. And Google’s advertising business is under attack.
The most obvious competitor is Amazon.com (NASDAQ:AMZN), who has ramped up its inventory and ad revenue. But smaller players are making inroads as well. Alphabet and Facebook (NASDAQ:FB) have had essentially an oligopoly on digital advertising for several years. In 2016, the two companies drove an estimated 99% of the growth in the category.
But that’s starting to change, as CNBC noted in August. The likes of Snap (NYSE:SNAP) and Twitter (NYSE:TWTR) are becoming worthwhile competitors. Big gains in adtech plays like The Trade Desk (NASDAQ:TTD) and the Rubicon Project (NYSE:RUBI) show that independent publishers and platforms finally have a path to growth.
Meanwhile, Google’s traffic costs are rising, and the shift to mobile presents another modest headwind. Guidance for higher spending led the Alphabet stock price to fall sharply after the first-quarter report in April.
And so the bear case here is that Alphabet’s earnings growth is going to slow because the core ad business is under pressure. “Other Bets” like Waymo, life sciences business Verily, and CapitalG are interesting. But particularly aside from Waymo, they don’t move the needle against a market capitalization still over $800 billion.
With efforts in hardware mostly disappointing – Google Home is well behind the Amazon Echo, and the Google Pixel flopped – there isn’t a third driver beyond advertising and Waymo. Even at ~21x earnings, that might not be enough.
The Case for Alphabet Stock
To be sure, it’s not as if the somewhat choppy trading in Google stock has been disastrous for investors. The stock still has risen 16% over the last year and has more than doubled over the last five.
GOOGL hasn’t necessarily been a star, but for the most part it’s well-tracked the performance of the NASDAQ 100 Index.
And there’s certainly a case that the Alphabet stock price still has double-digit annual gains ahead. Again, valuation is reasonable. Waymo may well be the leader in self-driving cars, depending on how an investor feels about Tesla (NASDAQ:TSLA).
That’s not the only potential growth driver. Google Cloud has driven optimism from analysts of late, including an upgrade from Deutsche Bank last week. It still has room to figure out how to monetize heavily-used products like GMail and Google Maps.
Even if advertising is seeing competitive pressure, it’s not as if 88% of revenue needs to come from advertising forever. This is a company with a user base in the billions. It has an enormous cash hoard that could support share repurchases or a transformative acquisition. Alphabet, simply put, has plenty of options.
As bearish as I’ve generally been on Google stock, I am sympathetic to that argument. Fundamentally, the stock looks cheap. Regulatory concerns seem overblown. Google is going to grow for some time, and at 21x 2019 earnings – and as little as 18x 2020 EPS – that alone is enough.
Still, there are risks here, and I’d be cautious ahead of Q3 earnings. GOOGL stock fell after Q1 and quickly gave back gains seen after Q3. The correlation with the NASDAQ 100 shows that market sentiment can move the stock, as it did in last year’s fourth quarter. GOOGL stock may well hold these levels. But I wouldn’t be surprised to see history repeat and the Alphabet stock price once again head toward $1,000.
As of this writing, Vince Martin has no positions in any securities mentioned.