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Alphabet in 4 Charts: Buy or Sell?

By Ryan Downie – Nov 11, 2021 at 7:50AM

Key Points

  • Alphabet's sales and profits can grow fast enough to outpace the market.
  • It operates efficiently and should maintain its competitive advantage.
  • Its stock has a cheap enough valuation to provide long-term gains.

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This tech stock looks really good on paper.

Alphabet (GOOGL 2.42%) (GOOG 2.51%) is one of the largest companies in the world (as measured by market cap), but that doesn't necessarily make it a good stock to buy.

An examination of some powerful charts (four in this case) related to Alphabet asa company and as a stock can tell investors a ton about the quality of its operations, its growth opportunities, and how expensive the stock is.

Investors who know how to analyze this data have a clear picture of where the tech giant stands -- and if they should buy or sell the stock.

Person analyzing financial chart on a computer.

Image source: Getty Images.

1. Alphabet's growth rate

Growth might be the very first box to check during investment analysis. Of course, growth isn't good enough on its own to justify an investment, and not all forms of growth are equal. Still, stocks generally aren't worth buying if they don't bring enough growth to the table. Long-term returns are ultimately based on future cash flows, so investors usually need to see expanding revenue and profits.

Alphabet offers attractive growth prospects. At its huge scale, it won't match some of the high-flying tech stocks that are growing 50% year over year. Alphabet's prospects are still more than good enough to outpace the market in general.

The company's operations have been hovering around 20% annual growth over the past decade, though it varies from year to year. It is, however, sustaining those growth rates for both sales and profits, which is important.

Chart showing rise in Alphabet's free cash flow since 2012.

GOOGL Free Cash Flow (3 Year Growth) data by YCharts. YoY = year-over-year.

Alphabet's historical consistency gives investors more confidence that it will continue along its growth trajectory. Its products, operational strategies, quality employees, and other factors all lay the foundation for ongoing expansion. Analysts are forecasting around 20% growth in the coming years, and it's a reasonable expectation. That's good enough for a "buy" rating in this regard on the growth aspect.

2. Alphabet produces solid ROIC

Return on invested capital (ROIC) is an important and under-utilized metric. It measures how well a business uses its financial resources to generate profits. ROIC gives insights on operational efficiency, pricing power, and the quality of the executive management team's capital stewardship. Stocks with high ROIC tend to be well-run. It's also evidence of an economic moat, which is a sustainable competitive advantage. Economic moats are important for stable profit margins and future growth.

Chart showing overall rise in Alphabet's ROIC since 2012.

GOOGL Return on Invested Capital (Annual) data by YCharts

Alphabet's ROIC is attractive at 18.2%. It's not the highest one out there, but it's good enough to get excited about the stock. Moreover, Alphabet could probably increase its profit margins -- and therefore ROIC -- in the short term by cutting some expenses. However, some of those expenses are necessary to keep up its high growth rate, and most long-term investors are happy to make that trade-off any day of the week.

This is another "buy" signal for Alphabet.

3. Alphabet is willing to spend on R&D

It might seem counterintuitive to prefer companies with high expenses, but this is an important exception. As long as Alphabet is producing high enough profits, it's good to see those excess funds invested in research and development (R&D). It's evidence of forward-thinking and commitment to product quality. Alphabet's product development expenses far exceed most of its peers and have for multiple years now.

Chart showing rise in R&D for several tech companies, including Alphabet, since 2012.

GOOGL Research and Development Expense (TTM) data by YCharts. TTM = trailing-12-months.

Alphabet's big R&D budget improves its current products and allows it to expand its offering in the future. It's an important step to securing future growth and maintaining its competitive position. That's essential when it competes with powerhouses such as Microsoft, Amazon, Apple, and Meta Platforms. This gives investors confidence that Alphabet will continue to flourish.

4. Valuation ratios suggest Alphabet stock is reasonably priced

Once we've established that Alphabet is operationally sound with a positive outlook, we have to confirm that the stock's valuation is reasonable enough to balance risk and reward. If it's too expensive, then all of the upside is already assumed in the price, and the stock is more likely to lose value or lag the market.

Alphabet isn't the cheapest stock on the market, but a few different valuation ratios indicate that it's priced reasonably enough to provide upside.

GOOGL Price to Free Cash Flow Chart

GOOGL Price to Free Cash Flow data by YCharts. EV = enterprise value. EBITDA = earnings before interest, taxation, depreciation, and amortization.

Alphabet's price is 30.9 times its free cash flow per share. That's not too steep for a company with decent growth. Similarly, the stock's EV-to-EBITDA ratio is very reasonable at 18.8. Alphabet's 27.5 forward price-to-earnings ratio can be adjusted for growth forecasts with the price-to-earnings-growth (PEG) ratio, which is only 1.4. That's good value relative to other tech stocks. Even though valuations across the stock market are near historically high levels, Alphabet's valuation metrics are still in line with recent historical levels.

Investor takeaway

The four charts above are conclusive. Alphabet is a well-run company with strong growth prospects, and the stock can be purchased at a reasonable valuation. It's worth considering for anyone's long-term investment portfolio.

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. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Ryan Downie owns shares of Alphabet (A shares), Amazon, and Microsoft. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Meta Platforms, Inc., and Microsoft. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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