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Motley Fool Issues Rare “All In” Buy Alert
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Alphabet (GOOG 0.22%) (GOOGL 0.13%) may be one of the most powerful companies in the world, but that hasn’t stopped it from getting swept up in the market sell-off this year.
Shares of the Google parent are down 33% year to date as fears of a recession, rising interest rates, and a slowdown in the ad market have combined to sink the stock.
However, sell-offs like these can often translate into buying opportunities. On that note, here are 10 reasons why Alphabet stock is a buy.
Most monopolies are banned by antitrust laws, but Alphabet has a loophole. Since the quality of a search engine improves as more users do searches, that makes search a natural monopoly. The industry doesn’t lend itself to competition, and that means it will be especially difficult for a competitor to unseat Google as the search leader.
Google has more than a 90% market share in search around much of the world, giving it tremendous market power, huge profits, and an entrenched brand in technology, and that’s unlikely to change.
Historically, Alphabet’s operating margins have hovered in the 25% to 35% range, as the chart below shows.
GOOGL Operating Margin (TTM) data by YCharts.
However, there’s more to it than that. Google’s core search business is even more profitable. In its most recent quarter, even as the overall business struggled, operating margin in Google Services, which includes its advertising business as well as hardware, Google Play, and YouTube subscriptions, came in at 32% compared to 25% overall for the company.
Alphabet doesn’t break out operating profit for individual businesses like Search, but it’s likely even higher than Google Services.
Google Cloud, Alphabet’s cloud infrastructure business, trails behind rivals like Microsoft Azure and Amazon Web Services, but it is growing quickly, with revenue up 38% to $6.9 billion in its most recent quarter. Unlike its two larger peers, Google Cloud is still losing money, but that should change over time.
Its margins are improving. The division’s operating margin narrowed from -14% to -10% in the third quarter, and management said on the recent earnings call that it is focused on a long-term path to profitability for the cloud segment. While it may never be as profitable as AWS or Azure, it should eventually be a significant contributor to the bottom line.
Part of the reason why Alphabet stock is down is that the ad market is slowing as businesses prepare for a potential recession. Alphabet’s revenue grew just 6% in the third quarter.
Advertising is a cyclical industry, and the same thing happened to the company when the pandemic began and during the financial crisis in 2008-09. However, the economy will eventually bounce back as we move through the cycle, and that means ad revenue at Google will accelerate too.
Image source: Getty Images.
In addition to its search and cloud businesses, Alphabet has a number of “moonshot” projects it classifies under “Other Bets.” The best-known of these is Waymo, its autonomous vehicle (AV) division.
Other Bets has lost more than $20 billion in the last five years and brought in little revenue; however, that could change. If AV technology ever breaks through, it will almost certainly be a massive industry. The company is also investing in life sciences projects, including fighting cancer and making anti-aging products.
Any of those projects could move the needle for Alphabet down the road.
It’s easy to argue that Alphabet has spent too much on Other Bets with little to show for it, but the company is planning to rein in costs, saying on the recent earnings call that it would slow hiring in the fourth quarter and into next year.
It’s unclear if it’s planning to apply the same cost discipline to Other Bets, but investors should be encouraged by the spending controls. While Alphabet hasn’t announced the kind of large-scale layoffs that fellow FAANG stocks like Meta Platforms and Amazon have, that’s also a possibility as CEO Sundar Pichai has said that productivity is not up to par.
Alphabet has long been a cash machine, but the company has stepped up efforts lately to return some of that cash to investors rather than just keep it on the balance sheet or spend it on projects like Other Bets.
Over the last year, the company has repurchased 433 million shares, spending $43.9 billion on stock buybacks over the last nine months. Those repurchases reduced its share count by 3.2%, and with the stock price down and $116 billion in cash and equivalents on the balance sheet, the company could get more aggressive with the repurchases, which will help increase earnings per share.
On a trailing basis, Alphabet stock trades at a price-to-earnings ratio of just 19.5, which compares to the S&P 500‘s at 20.5.
Price-to-earnings ratios are based on a company’s future earnings growth, so the market seems to be saying that Alphabet will grow profits more slowly than the broad market. Given the company’s track record, its dominance of search, and its share buyback program, that seems like a mistake. While the business may struggle over the next year if a recession hits, it will bounce back over the long term.
YouTube isn’t generally thought of as a major competitor in the streaming wars, but that’s changing. The video-sharing platform has no true peer on the free side, and paid options like YouTube TV and YouTube Premium should help the company monetize that sticky user base.
Together, the two services now have more than 80 million subscribers, up from 50 million a year ago, making the services a legitimate competitor to both Netflix and Spotify.
Since its 2004 IPO, Alphabet has returned nearly 4,000% to investors as the company has steadily grown revenue and profits.
Though the stock is down substantially over the past year, Alphabet is arguably stronger than it’s ever been. Its search monopoly continues to grow, and advertiser budgets have shifted from social to search following Apple’s crackdown on ad targeting.
The company has plenty of money to return to shareholders through buybacks, and the ad market should continue to grow over time, especially with the emergence of connected TV, including YouTube.
Despite the stock’s woes, Alphabet’s best days are still in front of it.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jeremy Bowman has positions in Amazon, Meta Platforms, Inc., and Netflix. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Meta Platforms, Inc., Microsoft, Netflix, and Spotify Technology. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
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