Better Buy: Facebook vs. Google

Two components of the FAANG group of stocks are Facebook and Alphabet, parent of Google. Both tech giants report third-quarter earnings on Thursday.

Over the long term, both companies have been extremely strong outperformers with long growth runways, high margins, and huge returns on capital. However, both companies have also recently faced scrutiny from antitrust regulators.

So which is the better buy today? Facebook and Google actually have similar financial profiles and valuations, so the choice will likely come down to what long-term trends you want to bet on as an investor.

Image source: Getty Images.

Digital advertising revenue and more

Both Alphabet and Facebook make the vast majority of their money from digital advertising -- in fact, Facebook basically makes all of its revenue from ads, while Alphabet made about 78% from ads last quarter. The other 22% came from Alphabet's cloud services, hardware sales, YouTube premium subscription services, Google Play app store sales, and its "other bets" segment. Alphabet's "other bets" segment invests in next-gen technologies like Waymo self-driving cars and Verily life sciences.

Data source: Q2 earnings release. Table by author.

Data source: Q2 earnings release. Table by author.

As you can see, Facebook's digital advertising grew 17% in the second quarter, while Google's digital advertising fell 8.1%. The COVID-19 pandemic greatly decreased search ads for the travel and leisure business. Meanwhile, Facebook was able to grow its MAUs 11.9% as people flocked  to social media amid the pandemic. It actually increased overall revenue per user, as many e-commerce businesses advertised on Facebook's hyper-targeted platform to reach at-home consumers.

Obviously, Facebook looks like the better digital ad business, at least for the pandemic. This is likely due to the types of advertisers each platform attracts.  

On the other hand, Google also has much better secondary businesses through its Google Cloud and Google other divisions. "Google other" revenue comes from the Play app store, YouTube premium and TV subscriptions, and its Nest, Pixel, and Chromebook hardware portfolio. And though search revenue was down, YouTube ads increased 5.8%.

So while Facebook's social media ads seem to be doing better than Google's search ads, Google has a more diverse revenue base, and those smaller segments grew strongly in the second quarter.

Valuation

Both Google and Facebook have excellent balance sheets and trade at fairly similar valuations:

Data source: Yahoo! Finance and Q2 earnings releases.

With similar P/E ratios, Alphabet has more of its market capitalization in cash, but Facebook is also supposed to grow earnings more rapidly over the next year.

Why Alphabet is valued higher despite lower near-term growth

Alphabet is likely valued a bit higher than Facebook due to the greater diversity of its businesses. Both cloud and the nonadvertising businesses are growing strongly, even as search ads falter due to the peculiar nature of the pandemic.

Alphabet thus combines coronavirus-resistant cloud and subscription businesses, while being a "recovery" stock as well. This combination makes it more compelling to me at the moment, despite the more difficult near-term situation. There are also free options from other bets, despite their making little revenue today. In fact, Waymo just launched its Waymo One self-driving car unit in Phoenix, AZ, this past month.

On the other hand, I couldn't fault anyone for preferring Facebook, as its main business is outperforming Alphabet's. However, investing in Facebook is more of a bet on the durability of its platform and digital advertising. Facebook may appear cheaper given current results, but it's also a bit riskier.

A word on antitrust

Of course, both companies are under the microscope of antitrust regulators. It's difficult to know if or how the government will penalize or regulate these two companies. Based on the case put forth, I don't think these companies' core businesses are under threat as of now.

Moreover, any antitrust enforcement that does happen will take a long time to play out. In the meantime, both Facebook and Google are high-quality companies trading at very reasonable prices today, perhaps because of these regulatory concerns. I view both as bargain opportunities, as both companies are buying back stock. If I had to pick, I'd lean toward Alphabet due to its diversity and potential upside surprises.