One of the most dominant companies globally, Alphabet (GOOG 9.96%) (GOOGL 10.22%) owns the Google search engine, YouTube video platform, and Android operating system. Alphabet is down more than 20% from its all-time high despite no business slowdown, and now looks like a good time to buy shares. Investors might be worried about a recession taking its toll on Alphabet, but the words "recession" and "slow" weren't even mentioned in company's latest earnings call.
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One of the world's most impressive businesses is trading at a discount
Alphabet's properties dominate, with Android having an estimated 71% market share among mobile operating systems and Google having desktop search engine market share of an estimated 86%. YouTube leads in online video platforms and Google Cloud also makes a mark though it trails Amazon's AWS and Microsoft's Azure.
It's not hard for the stock of a leader in business segments as big and important as these to fetch a premium, however, Alphabet's stock trades at about the same valuation as the S&P 500, which consists of the stocks of the 500 largest companies in the U.S. Currently, the S&P 500 trades for about 19.7 times earnings, nearly identical to Alphabet.
GOOG PE Ratio data by YCharts
Not only does Alphabet trade around the S&P 500's price-to-earnings (P/E) ratio, it is trading at its lowest valuation in the past decade. Alphabet makes up nearly 4% of the market-cap-weighted S&P 500 and is the third-largest component, but the other top five businesses trade at a much higher valuation than Alphabet. A multiindustry leader like Alphabet trades below the average. To me, this doesn't make sense.
What could cause the market to do such an odd thing? Fear.
Investors fear a recession will affect advertising revenue
Fears of a recession are swirling around the market, and recessions typically cause businesses to slash their advertising budgets. A decline in sales could be a big deal to Alphabet, as 80% of its first-quarter revenue was derived from advertising dollars. Fear of this happening is why the stock is trading at a discount to the overall market's earnings multiple.
However, I believe this fear is overblown.
Last quarter, Alphabet's total revenue grew 23% year over year, with its ad business growing 22%. As of Q1, Alphabet hasn't seen any advertisement spending slowdown and while it might in the future, I'm taking comfort from its continued strength.
If a recession does affect Alphabet's growth, it would still be a cash-generating machine. In Q1, it turned 23% of revenue ($15.3 billion) into free cash flow. Free cash flow will get added to Alphabet's massive current cash pile of $140 billion, which can be used to pay for share buybacks, fund acquisitions, or pay down debt.
Alphabet also spent nearly $10 billion on property and equipment in Q1, the most it has ever spent during a quarter. If Alphabet were feeling pressure, it could cut back on spending for new offices and data centers.
I'm not worried
I think too many investors are applying Snap's cut to its advertising revenue guidance to Alphabet. But that's comparing the world's 12th most-utilized social media company (in terms of monthly active users) to the biggest search engine and video platform worldwide. I do not doubt Snap management's guidance, but its platform doesn't rank as high on the list of places where businesses spend their advertising budgets.
Advertisers value YouTube and Google more than they do Snap, so a drop in advertising for Snap would not necessarily mean a drop for Alphabet.
Could a recession occur that dings Alphabet's revenue? Absolutely, and we don't know when. However, an earnings decline is already baked into Alphabet's valuation, as its P/E ratio is the lowest it has ever been. If Alphabet reports solid numbers in Q2, I'd expect the stock to rocket higher as skeptics are proved wrong.
Today represents a fantastic buying opportunity to own one of the most dominant companies in the market. While I don't know precisely when the stock's turnaround will come, I'm confident the price will be greater three to five years down the road due to the dominance of the brands under its umbrella.
