- The key to Alphabet (GOOGL, GOOG) stock remains its cloud
- The cloud, bought with cash flow, is a huge and reliable profit generator
- You can buy the stock now or wait for the inflation bear to stop biting
When everything is falling, you will find shelter in what’s real. Few tech stocks are more real than Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).
Shares in Google’s parent fell 22% for 2022, through May 11. An overnight bounce had them set to open at $2,300. They were near $3,000 as recently as February.
The shares have mirrored the larger NASDAQ. Google now has a market capitalization under $1.5 trillion. Its forward price to earnings ratio is about 20 times. We don’t have to talk about things like EBITDA or price to sales because the company made over $110/share in net income over the last year.
With 30-year bonds now yielding nearly 3.2%, it’s hard to talk about any tech stock being a bargain. But Alphabet is one of the rarities. The reason is not obvious.
| GOOGL, GOOG | Alphabet | $2,279.22, $2,272.05 |
Why Buy Google Now?
Most Google bulls will talk about its ad-based search services or YouTube. They might look at its growth of over 40% in 2021. They might write about Google Cloud, still growing fast but not yet profitable in the company’s first-quarter earnings release.
More important than any of that is the cloud itself. This consists of 23 data centers around the world, 14 of them in the U.S., along with fiber cables connecting them.
Don’t be confused between these long distance lines and Google Fiber, the money-losing local service still listed among the company’s “Other Bets.” The long distance service is infrastructure serving Google itself, and some Google Cloud customers.
What matters here is that Google owns all its infrastructure free and clear. It was bought over time with cash flow, almost $10 billion in the first quarter alone. That still left $15 billion in “free cash flow,” listed either as part of the $133 billion of cash and securities on the first quarter books, or dedicated in $70 billion of buybacks over the next year, meant to prop up the stock.
I call Google a “Cloud Czar” because its ownership of infrastructure makes it the landlord for other cloud players. It’s a status it shares with Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Amazon.Com (NASDAQ:AMZN) and Meta Platforms (NASDAQ:FB).
Revenue Google generates renting its infrastructure, or its application software, isn’t encumbered by the cost of getting it to you. Google, of course, also gains insights into its markets, if just from the bills it collects from businesses using its cloud.
What’s It Worth
Alphabet’s first quarter results were called a “miss” because it came up $40 million short on analyst revenue estimates, and $1.12/share short on earnings. Most of the earnings miss came on losses from Google’s own equity investments, which fell with the general market.
Naturally, this sent reporters searching for other reasons. YouTube is supposedly threatened by TikTok. All the Czars are being “underweighted” by investors desperate to save themselves from ruin. There’s panic throughout the stock market on concerns about the global economy.
None of this represents serious trouble for Google unless you think TikTok is going to replace all video. Google revenues are still rising at 23% year-over-year. While costs rose $9 billion, revenues rose $13 billion. Google uses GAAP accounting. These are conservative numbers. This is real.
The Bottom Line
As interest rates rise, the price investors pay for earnings falls. This happens for all companies, including Google.
A 3.2% general interest rate means you’re paying about 30 times earnings to own a safe government bond. Any other return carries risk, including safe stocks like Google.
If interest rates keep rising, say to 5%, the PE of safety drops to 20, and Google stock is certain to fall further.
But I don’t see that happening, at least not for long. The deflationary impact of Google’s technology remains strong. The strong dollar means imported goods cost less. The panic will end and, when it does, you’ll be glad you own Alphabet.
On the date of publication, Dana Blankenhorn held long positions in AMZN, GOOGL, AAPL and MSFT. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
