While stock splits don't change the intrinsic value of any company or stock, the increased liquidity that comes with a smaller per-share price could unlock interest from smaller retail traders. Therefore, buying stocks ahead of a stock split could lead to a short-term bump. After all, top tech stocks that have split their shares in recent years have typically gone on to do well.
But a split alone is no reason to buy a stock for the long term, a style we preach at the Fool. Nonetheless, if you think a pre-split stock is undervalued based on its business prospects, then by all means, buy ahead of the split.
Here are five reasons Alphabet (GOOG 0.36%) (GOOGL 0.29%) looks undervalued today, making it a strong buy just a few months before its upcoming 20-for-1 split in July.
1. A near monopoly in high-growth search
Alphabet has arguably the best business ever created in its Google Search engine. Some 20 years ago, Google established itself as the dominant search engine in the world, which benefits from strong network effects. The more people use Search, the more Google can scale, glean data, and invest back into its algorithms to make it even better. That attracts more and more use in a virtuous circle. And because of its global scale, it's a hugely profitable, capital-light business.
While Google Search has been dominant for so long, some might think it's a mature business. But Search ads grew a whopping 43% last year. While some of that is a bounce back from the pandemic, the digital advertising business should continue to grow by midteens percentages this year, and around 10% for the next two years after that, according to Zenith Media. Yet Google outgrew the digital ad market last year, which Zenith estimated at around 25% growth.
It's entirely possible Google outgrows the digital ad market again this year and beyond. After all, changes to the iOS operating system implemented in 2021 will make ad targeting more difficult for social media companies. That has pushed more ads over to Google starting late last year, which doesn't require as much third-party data, since people are freely volunteering what they are searching for.
And Google's YouTube business also benefits from the voluntary searching, which also led to strong growth at the smaller video-ad segment. Overall, Alphabet's digital ad empire across Search, YouTube, and third-party network partners is as strong as ever.
2. Google Cloud
The only business that might be better than Search advertising is enterprise cloud infrastructure, which is dominated by just a few tech giants. That's because only these giants have the financial and technical resources to provide secure enterprise cloud services globally outside China.
Combined with this attractive oligopoly, the cloud infrastructure market has some of the most promising growth prospects. Research firm IDC projects 28.8% annualized growth for the infrastructure and platform-as-a-service businesses through 2025.
The top three cloud providers -- Alphabet is third behind Amazon (NASDAQ: AMZN) and Microsoft (NASDAQ: MSFT) -- have been growing even faster than that, consolidating market share. For its part, Google Cloud Platform grew 47% in 2021, outdoing the industry.
Since Google Cloud was a late entrant in the cloud computing market, it's still losing money. However, it's scaling well with growth; operating losses narrowed a lot last year, from $5.6 billion in 2020 to $3.1 billion in 2021. Of the $6.1 billion in incremental revenue, roughly $2.5 billion, or 41%, fell to the bottom line. Should Google Cloud keep scaling this efficiently, it could be a very profitable business in the not-too-distant future, as are the earlier movers in the space.
Image source: Getty Images.
3. Other Bets, groundbreaking research, acquisitions
While Alphabet got a late start in cloud computing, one reason companies might choose Google's Cloud could be for its unique and advanced tools. Alphabet has made huge investments in artificial intelligence across its platform, not only for Search and Cloud, but also in its Other Bets segment -- a portfolio of high-risk, high-upside bets in advanced technology. These include fields such as self-driving cars, life sciences data-driven innovation, and even quantum computing.
Alphabet has also been willing to make tuck-in acquisitions for key technologies. In recent years, it bought health tracking company Fitbit, and just agreed to buy cybersecurity firm Mandiant for $5.4 billion, among others.
Fortunately, its core ad business is so profitable that the company can afford to hire top engineers in advanced science, make acquisitions, and make bets on long-term technology trends. That commitment to futuristic research and development (R&D) not only enriches current services, but also lays the groundwork for future breakthroughs.
4. Alphabet is also returning more cash to shareholders
That commitment to R&D used to give Alphabet a reputation as a "loose" spender from skeptics, throwing money at pie-in-the-sky ventures. But in 2015, Sundar Pichai took over as CEO from Larry Page, and Ruth Porat, the former chief financial officer of Wall Street bank Morgan Stanley, became Alphabet's CFO.
A few years after Porat came on board, Alphabet showed more financial discipline and a willingness to return profits to shareholders in the form of stock buybacks. Since 2018, its share count has been steadily declining, increasing shareholders' portion of Alphabet's business:
GOOG data by YCharts.
Of course, Alphabet generates so much in profit that it still has a healthy cash balance, to the tune of about $140 billion as of the end of 2021. Its core ad businesses are so good, shareholders can have their cake and eat it, too.
5. A cheap valuation
Whether due to its high per-share price or a misunderstanding of its various parts, Alphabet seems quite undervalued. Currently, it only trades at less than 25 times this year's earnings estimates. That seems like a very reasonable valuation for a company that grew revenue by 41% and operating earnings by 91% in 2021.
But keep in mind that Alphabet's earnings are currently held back by losses at Google Cloud and Other Bets. Last year, losses from Cloud and Other Bets totaled almost $8.4 billion, which lowered Alphabet's operating income by almost 10%. If you think that Cloud and Other Bets have any positive value at all, then you are buying the core ads business for an even lower multiple.
Compared with loss-making but high-growth software stocks growing at similar rates, Alphabet looks downright cheap. That's why investors should have no qualms with buying the stock ahead of its July split.
