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2 Reasons Why Alphabet Is Undervalued

By Kyle Salvitti - Feb 24, 2021 at 8:18AM

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Investors are overlooking one of the largest companies in the world.

Many investors often shun the biggest names in the market because they believe that these companies are so obvious that they cannot possibly be undervalued. But one tech titan has likely been hiding in plain sight: Alphabet (GOOGL 2.30%). Even though the general market may currently seem overvalued, here are two reasons why the advertising giant is not.

Woman pointing to a stock chart that is growing

Image source: Getty Images.

1. Google Cloud

Google Cloud is developing into a significant source of revenue and growth for Alphabet. Even though Amazon (AMZN 4.97%) and Microsoft (MSFT 1.14%) dominate the cloud computing industry, Google still comes in at third with 9% of the market share as of the end of 2020 -- up from 5% in 2017. This segment of Alphabet grew 46% year over year in 2020; its revenue has risen from $5.838 billion in 2018 to $13.059 billion at the end of 2020. The onset of COVID sped up businesses' shift toward the cloud, as working from home and videoconferencing became the norm. Alphabet continues to invest in its cloud platform, creating collaboration tools and a robust data analytics platform for its customers, which should allow it to continue to take some market share from the other large players. While Google Cloud is not currently profitable, the public cloud market is valued at $236 billion, providing a meaningful runway for Google Cloud to grow and develop.

2. YouTube

Google is the most visited website globally -- and the second most visited is YouTube, its wholly owned subsidiary. YouTube alone experiences over 34.6 billion monthly visits globally and over 1 billion minutes watched on the platform daily. YouTube is the second most popular search engine behind Google. It is also the most popular video platform site with over 2 billion monthly active users.

Ad revenue on YouTube grew by over 46% from 2019 to 2020. It is likely to grow further since YouTube TV is the second largest connected television (CTV) platform, bringing in $1.5 billion in CTV ad revenue alone.

YouTube stands to benefit from the current cord-cutting trend. Over 27% of U.S. cable subscribers plan to cut the cord in 2021; among those who already have, YouTube TV already commands 19.6% of this market. In June 2020, Alphabet mentioned that over 100 million viewers watch YouTube and YouTube TV on their TV screens each month.

This abundant traffic gives Alphabet access to the best consumer data available. Because of the massive network Alphabet has in YouTube and YouTube TV alone, advertisers have to work with Alphabet in order to reach the most viewers. Very few platforms have the reach and data that Alphabet can offer through YouTube, making it very difficult for advertisers to move away from YouTube to another platform.

And since YouTube has such a massive user base already, Alphabet can effectively advertise YouTube TV to billions of individuals at very little cost. This has enabled YouTube TV to swiftly become a dominant player in the streaming space.  Streaming is expected to grow 18.3% per year on average between now and 2026, giving YouTube TV an excellent opportunity to grow even prominent in the future as its platform and network continue to attract new viewers.

Alphabet can make YouTube even more lucrative as it increases the site's average revenue per user, or ARPU. YouTube experienced about $7.50 in revenue per active monthly user in 2020. Compare that to Facebook (FB 3.51%), which posted an ARPU of $7.89 in the third quarter of 2020 alone  -- making more per user in three months than YouTube did in an entire year. If YouTube can grow to command even a fraction of Facebook's ARPU, it will drive even more value to Alphabet's top and bottom lines. 

Valuation

Even though Alphabet is one of the world's biggest companies, valued at over $1.4 trillion, it is still very much a growth company. Its market share in online advertising has been slowly declining, but it still commands over 30% of the U.S. ad market. According to the market research firm Morningstar, the digital ad market is expected to grow an average of 14% per year from 2022-2024. Alphabet stands to benefit from the growth of the ad market and from the growth YouTube is experiencing. 

Alphabet also managed to grow operating profits by 20% in 2020, which is impressive for such a massive company. With operating margins around 23%, Google is wildly profitable, allowing management to reinvest in the business continually.

Shares currently trade at a forward price-to-earnings ratio of 26 times on average, and about 20 times on the best-projected earnings. With the S&P 500 trading at a forward P/E of 25.35 times, Alphabet looks like a steal by comparison. Investors can own one of the highest-quality businesses globally for almost the same multiple as the S&P, without owning the number of not-so-great companies that come with the index. Owning just Alphabet since the start of 2020, investors would have seen a 54% return, whereas investors in the index would have only gotten 18%, highlighting the drag these other companies in the index had.  

It's hard to believe that a company as widely recognized and discussed as Alphabet might be undervalued. But over the long run, the YouTube platform and continual investments in Alphabet's cloud offering are likely to create a lot of value for investors. 

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$2,164.82 (2.30%) $48.73
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$265.51 (1.14%) $2.99
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$2,241.60 (4.97%) $106.10
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
FB
$190.28 (3.51%) $6.46

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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