Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) stock has traded sideways in the past six months on concerns about regulatory crackdowns. Although Alphabet has put up impressive growth numbers, investors have shied away from Google stock.
I’ve previously written about why the owners of Google stock shouldn’t worry about regulatory and antitrust actions. But a new, deep dive into Google’s finances highlights just how much value GOOGL stock could create for investors over the long-term.
Litman’s Take on Google Stock
Valens Securities CIO Joel Litman has created a proprietary methodology for analyzing companies’ financial statements. His system makes a number of adjustments to get a clearer picture of a company’s long-term earnings trajectory and financial health. Litman calls his approach “unicorn accounting,” and he recently applied it to Google stock.
The first thing that stands out is Alphabet’s long-term return on assets. or ROA. The company’s official ROA over the past five years has been in the 8%-10% range. That level is barely above the long-term, average U.S. corporate ROA of 6%.
However, Litman says Alphabet’s treatment of its excess cash, its research and development capitalization and its expensing practices have muddied the ROA waters.
Litman’s adjustments reveal that Google is more than twice as profitable as its numbers suggest. It has also generated adjusted ROA of above 25% in each of the past five years, according to Litman.
At the same time, Alphabet is dumping tons of cash into new growth opportunities. Those investments are setting the stage for future earnings growth that will boost Alphabet stock price over the longer term.
“This is a world-class, cash-gushing machine,” Litman says of Alphabet.
The most encouraging part is that Google stock seems to be pricing in steady declines in Alphabet’s ROA. Litman says this phenomenon is likely due to Wall Street’s failure to appreciate just how profitable Alphabet is.
While he says GOOGL stock appears fully valued based on current, reported metrics, the market may be surprised at how durable Google’s ROA levels are.
“Uniform Accounting shows that (Alphabet stock price) has significant upside potential from here,” Litman says.
Google’s High-Growth Outlook
I believe GOOGL stock is a growth stock that’s trading at a value stock price. Its revenue is growing at an annual rate of roughly 20%, which is impressive for a company of any size. In addition, there’s no reason to think Google can’t maintain that growth rate.
Google is exposed to some of the largest and highest-growth tech sectors in the market. It is a market leader in internet and mobile search, online advertising, artificial intelligence, cloud services, machine learning and autonomous vehicles.
At the same time, Google stock is trading at just 21.6 times analysts’ average forward earnings estimate and 5.5 times its sales. Assuming the company’s reasonable margins and market multiples remain steady in coming years, Alphabet stock price should appreciate in-line with its growth. Last quarter, its revenue jumped 19% year-over-year and its EPS soared 213%.
In many respects, GOOGL stock is like a cheaper version of Amazon (NASDAQ: AMZN). For years, Amazon bears ranted about the stock’s extremely high valuation. But the company’s true earnings and cash-flow potential were being clouded by its massive investments in cutting-edge technology. Alphabet is now in the same position as AMZN was, except Google stock doesn’t have a P/E ratio above 70 like Amazon did. As Alphabet’s numbers more accurately reflect its underlying business over time, Alphabet stock price should follow suit.
A Positive Catalyst for GOOGL Stock
Ironically, I believe all the antitrust concerns that have weighed on GOOGL stock this year will ultimately end up becoming a positive catalyst for the shares. The absolute worst environment for a stock is one of uncertainty. There’s something about human nature that makes us assume/prepare for the worst when an outcome is uncertain.
I’d be willing to bet that the conclusion of these antitrust investigations will be a majorm positive catalyst for GOOGL stock.
First of all, politicians and regulators are likely not going to throw the book at Google or any other big tech companies. As I’ve said before, there’s nothing illegal about running a massively large business. To be broken up on antitrust grounds, a company must be using its size to unfairly suppress its competition. Given the relatively small number of breakups of companies by regulators in U.S. history, noncompetitive practices have to be pretty extreme to warrant a breakup.
Regulators will likely only slap Google with a fine that won’t make a dent in the company’s roughly $10 billion of quarterly net income.
Regardless of the outcome of the antitrust probes, the uncertainty will be gone once they conclude, and investors will no longer have to worry about them. Even a breakup, which is the worst-case scenario, could ultimately lead to value creation for investors.
Google stock is a classic case of near-term uncertainty versus long-term value. I can’t say where Google stock will be five months from now. But imagining where it will be five years from now should make anyone want to buy the stock.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.