For most stocks in most years, a 4% gain through mid-May wouldn’t be particularly impressive. But Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) stock has somehow managed a 4% gain in 2020. This year, even a 4% gain is something to write home about.
Google’s parent company has consistently been the most under-the-radar FAANG stock of the past three years. Alphabet stock lagged behind high flyers like Netflix (NASDAQ: NFLX) and Amazon (NASDAQ: AMZN) by a wide margin in the past three years. However, GOOG stock has still more than doubled the S&P 500’s overall return in that stretch.
There are still plenty of things to love about GOOG stock, even after a 9% rally in the past month. Here are five reasons investors should be scooping up shares.
Ad Revenue Is Stabilizing
Alphabet’s first-quarter earnings suggested its online advertising business certainly wasn’t immune from Covid-19 disruption. However, it’s numbers were actually pretty good considering the current situation.
Overall revenue was up 13.2%. Net income was up 2.6%. YouTube ad revenue was up 33%. Perhaps most importantly, management said search revenue declined in the mid-teens percent range in the second half of March, but appears to have stabilized in April. YouTube ad revenue was still up in the single-digits during that stretch.
Clearly, the shutdown is not ideal for GOOG stock given companies are slashing ad budgets. But Google’s ad business is relatively insulated given many businesses are completely shut down. The earnings call commentary indicates the company may have already navigated the worst of the crisis with minimal damage.
Economic Shutdown Is Driving Ad Dollars Online
Ad spending is falling almost across the board. But there are a couple of silver linings for Google. First, traditional media advertising is likely getting hit harder than online advertising. Second-quarter traditional media ad spending is projected to be down 39% compared to 33% for online ad spending, according to IAB. But when advertisers eventually ramp that spending back up, a higher percentage of it will likely go online.
Second, engagement and usage on YouTube are skyrocketing due to shelter-in-place orders. If Google retains even a modest percentage of this engagement after the crisis, its average revenue per user could jump in time.
Google’s Innovation Can’t Be Stopped
The economy may have completely shut down, but Google’s innovation has kept right on rolling. Google has always focused on the long-term when it comes to creating new products and services. Morgan Stanley analyst Brian Nowak says Google may not be able to capitalize on many of its innovations for years to come. But the company is creating long-term value.
“We are particularly positive on its emerging e-commerce products (shopping listings, virtual show rooms, deep linking, etc), focus on [small and medium-sized businesses], and efforts to drive digital transformation in the healthcare and education industries,” Nowak says. Google’s Waymo autonomous vehicles business is also the market leader in AV technology, according to Navigant Research.
Google’s Business Model Is Solid
The Covid-19 downturn has been a struggle for companies with distressed balance sheets and excessive cash burn. Not only was Google still profitable in the first quarter, it is cutting costs to make its business even more efficient. The company has reduced hiring, cut non-essential business travel and marketing expenses and is focusing on optimizing its data center business.
Morgan Stanley has cut its projections for Google 2020 and 2021 capital expenditures by 13% each. Not only will this discipline help Google weather the downturn, it will also make it a more efficient and productive business when the recovery finally takes hold.
Finally, Alphabet still has enough cash flow left to buy back shares of stock. The company reported $8.5 billion in buybacks in the first quarter, which will help support earnings per share.
GOOG Stock Is A Compelling Value
GOOG stock is one of the few true growth stocks that is not also overvalued. It trades at just 25.5 times forward earnings and 5.7 times sales. For a tech stock generating double-digit revenue growth, those types of reasonable valuations are a rarity.
For example, Amazon trades at 64.2 times forward earnings. Netflix trades at nine times sales. Many growth stocks in the tech sector have valuation air pockets under their share prices.
Morgan Stanley values GOOG stock at about 12 times projected 2021 earnings before interest, taxes, depreciation and amortization, which is in-line with the stock’s historic median multiple. The firm has an “overweight” rating and $1,400 price target for GOOG stock.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan was long GOOGL stock.
