Image source: Alphabet.
Facebook (META 0.43%) stock is on fire lately. Shares of the social network are up by a staggering 35% in the past year. However, past performance is no guarantee of future returns, and investment decisions need to be made by looking through the windshield, not in the rearview mirror.
For investors looking to make the best possible bet in online advertising, industry leader Alphabet (GOOG 9.96%) (GOOGL 10.22%) could be a better choice than Facebook at current prices.
Kicking the tires
Facebook is delivering extraordinary results for investors, so it's no wonder the stock is doing so well. Based on data for the fourth quarter of 2015, Facebook ended the year with a gigantic user base of 1.59 billion monthly users, a 14% increase over 2014. Not only that, but the company is also growing rapidly in mobile, a key segment in the industry. Facebook had 1.44 billion monthly mobile users as of the latest earnings report, a vigorous 21% increase.
Management is doing an amazing job of translating that user growth into increasing revenues for investors. Facebook produced $17.93 billion in total sales over 2015, an impressive 44% increase in U.S. dollars. Even better, constant currency sales jumped 66% versus the prior year.
Alphabet produced almost $75 billion in total sales during 2015, meaning Facebook is just 24% the size of Alphabet in terms of revenue. Because of this difference in size, Alphabet can't be expected to grow as rapidly as Facebook, but the company still delivered a big 24% year-over-year increase in constant currency sales during the last quarter of 2015. This performance is nothing short of exceptional coming from a company as big as Alphabet.
Alphabet is the undisputed king in online advertising thanks to the popularity and ubiquity of its Google business. Google is one of the most valuable brands in the world. The name is so popular that many consumers are use the term "googling" as a synonym for online search. As of the end of 2015, Google owned seven properties with over 1 billion monthly users each: Google Search, Android, Maps, Chrome, YouTube, Google Play, and Gmail.
The online advertising business provides big and stable cash flows for Alphabet, and the company is investing for growth in innovative and highly disruptive areas such as self-driving cars, high-speed connectivity, outer-space exploration, and futuristic health-care initiatives, among others. These projects have little economic visibility in the short term, but they could represent exceptional opportunities for growth over the years ahead.
In terms of competitive position in online advertising, no company is more dominant than Alphabet and its Google business. Scale can be a limitation when it comes to growth, but Alphabet is still delivering impressive performance for a company of its size. What's more, investments in all kinds of innovative industries could fuel Alphabet into sustained growth over the long term.
Checking the price tag
Chances are that Facebook will continue outgrowing Alphabet over the coming quarters; however, this expectation is already incorporated into valuation ratios to a good degree. At current prices, Facebook stock is priced for demanding expectations, and it doesn't offer much room for error in case there's any disappointment down the road. Alphabet, on the other hand, is priced at far more reasonable levels.
Alphabet stock is currently trading at a forward price-to-earnings ratio in the neighborhood of 19 times earnings expectations for the coming year. That's a slight premium to the overall market, as the average company in the S&P 500 index trades at a forward price-to-earnings ratio of around 18. Alphabet is an above-average business in terms of quality and potential for growth, so the stock looks fairly attractively priced.
Facebook, on the other hand, trades at a much higher forward price-to-earnings ratio of around 30. That doesn't mean the stock is necessarily overvalued. After all, Facebook is one of the most impressive growth stories in the tech sector nowadays. However, the higher the expectations, the tougher it will be for the company to outperform those expectations, and current valuation ratios reflect that the market is clearly expecting a lot from Facebook.
Facebook is outgrowing Alphabet, and chances are that this will continue to be the case over the coming quarters. Nevertheless, Alphabet offers indisputable quality and rock-solid competitive strengths, and the stock is more attractively priced. All things considered, Alphabet looks like a better choice than Facebook going forward.
