The U.S. equity market has had a difficult ride in 2022. Rising inflation and subsequent interest rate hikes, geopolitical tensions, and stalling economic growth have been exerting downward pressure on the tech-heavy Nasdaq Composite. The recent sell-off has unduly punished many high-quality tech stocks. Technology giant Alphabet (GOOGL -0.77%) (GOOG -0.75%) is one such stock and not even an upcoming stock split has been able to save the company's shares from the downfall.
A major beneficiary of stay-at-home requirements during the COVID-19 pandemic, Alphabet's Class A shares are currently down about 24% from their all-time high of $3,030.93. Besides challenging macroeconomics, the stock is also suffering due to tough year-over-year comparisons associated with an unusually solid performance in 2021, from intensifying competition between its video platform YouTube and competitor platform TikTok, as well as a difficult environment for the overall digital advertising industry.
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Despite these headwinds, there are several factors -- some driven by investor sentiment and others based on solid fundamentals -- that make Alphabet an attractive pick now. Let's review a few of them.
A stock split is upcoming that could spark share-price appreciation
In the fourth-quarter earnings conference call on Feb. 1, Alphabet management announced plans to go ahead with a 20-for-1 stock split effective July 15. A stock split does not change the intrinsic value of a stock. However, it has been seen that split stocks usually witness significant share-price appreciation in a time frame of one-to-three years post-split.
As the split stock becomes cheaper in absolute terms, it becomes more investable, especially for investors with limited capital. The high anticipation of post-split share-price appreciation also pushes up the company's stock price in pre-split days, as short-term investors may see this as an opportunity for a momentum trade. Alphabet also stands to benefit from these emotion-driven factors in the coming months.
Google Cloud and Google Search continue to be major growth drivers
According to Gs.statcounter.com, Google Search accounted for a 92% share of the global search engine market in February 2022. Subsequently, the company is well-positioned to capture a significant portion of the global digital advertising market. In 2021, Google dominated the U.S. digital advertising landscape with a 28.6% market share. The strong moat in the online search and digital advertising markets will help the company to fare strongly even in a recessionary environment.
Google Cloud accounted for a 10% share of the $180 billion global cloud infrastructure market in the fourth quarter of 2021. Although not yet profitable, Google Cloud has been increasing its top line at a rapid clip. In the first quarter, Google Cloud's revenue was up by 44% year over year to $5.8 billion. Although Amazon's (AMZN -1.07%) Amazon Web Services (AWS) is the leading cloud player with a 33% market share, Google Cloud has outpaced it in top-line growth rate. In the first quarter, AWS reported year-over-year revenue growth of 37%. With gradually declining losses, Google Cloud is on the way to becoming a major growth driver for Alphabet in the coming years.
Alphabet has robust financials and strong balance sheet
In the first quarter (ending March 31), Alphabet reported revenue of $68 billion, up 23% year over year and in line with the consensus estimates. The company's earnings per share (EPS) rose 7% year over year to $24.62 but missed the consensus estimate of $25.74. Although the performance was weaker than that seen in 2021, double-digit top-line growth and a 30% operating margin are quite impressive, especially in the current difficult environment.
Alphabet also boasts a robust balance sheet with total cash and marketable securities of $134 billion and total debt of only $28.6 billion. Google Search engine and YouTube have been practically minting money for the company. In the first quarter, Alphabet generated a healthy free cash flow of $15.3 billion.
Alphabet has a reasonable valuation
Alphabet's share price is currently down about 21.4% so far this year.
GOOG PE Ratio (Forward) data by YCharts
The stock is currently trading at 20.07 times forward earnings -- the lowest it has been in the past year. The valuation seems cheaper when we consider the possibility of the company getting added to the Dow Jones Industrial Average after the stock split. The company also plans to repurchase Class A and Class C shares worth $70 billion -- a move that can significantly bring down the company's outstanding shares, which in turn can result in improved earnings per share for remaining shareholders.
Alphabet stock is an attractive pick now
While Alphabet's challenges cannot be ignored, the company still has many positives in its favor.
Alphabet dominates the global online search market and digital advertising market, and it is making rapid inroads in the global cloud market. The company has been reporting impressive financial performance. The company also generates loads of free cash flow, which can be used for organic and inorganic growth initiatives as well as for returning capital to shareholders. This coupled with a solid balance sheet and cheap valuation makes this stock an attractive pick now.
