Search engine giant and internet company Alphabet (GOOGL 0.93%) (GOOGL 0.93%) went years without much adversity. The stock delivered life-changing returns, turning a $10,000 investment into more than $360,000 over its lifetime.
But the explosion of interest in artificial intelligence (AI) has Wall Street questioning Alphabet's long-term future. The stock is down almost 40% from its high, which puts its valuation at its lowest in some time.
While one shouldn't dismiss the threat of innovation, Alphabet has become an opportunity to score double-digit price returns moving forward without taking on excessive risk. Here is what you need to know.
Alphabet's valuation reflects investors' fear
The company doesn't need much introduction; Alphabet is one of the world's most powerful technology companies. Anyone who uses the internet has likely heard of either Google Search or YouTube; these two sites are the most heavily trafficked in the world. Selling ads to the global population that frequents these sites is how Alphabet makes most of its money.
Alphabet's success jumps out when you put it in chart form; the business continues growing and printing free cash flow, generating $0.21 of cash from every revenue dollar.
GOOGL Revenue (TTM) data by YCharts.
You might expect such a profitable business to command a hefty valuation, but today the stock trades at a forward price-to-earnings ratio (P/E) of 16.5, right on par with the S&P 500 (a stand-in for the broader stock market). The S&P 500 has historically grown earnings by an average of 10% to 11% yearly. According to analysts, Alphabet could average 14% annual earnings growth over the next several years.
One could argue that Alphabet should trade at a premium to the market on its growth alone, not even considering that its P/E is well below its average over the past decade (an average P/E of 29). So why doesn't it? Mr. Market can be silly; a bear market with rising interest rates and buzz over ChatGPT is an excellent place to point the finger.
But what about ChatGPT?
Investing is a "what have you done for me lately" type of business, so I get why investors are looking at ChatGPT and AI as a threat to Alphabet's golden goose. It's the cool new kid in school. However, a lot must happen to realize a worst-case scenario. For starters, Google owns nearly 85% of global search inquiries.
Something like Microsoft's Bing would have to be such a superior product that it overcomes the mental training that comes with years of using something (Google) hundreds or thousands of times. I'm not saying it can't happen, but consider pumping the brakes considering that Microsoft's revamped Bing isn't live yet and has erred in answering inquiries.
Alphabet's also not sitting on its hands; the company is developing its chatbot offering in Google Bard. Ideally, Google will evolve to maintain a great user experience, including implementing chatbot features if needed. Again, this is something worth monitoring moving forward and not immediately panicking over.
Can Alphabet beat the market?
The stock's beaten the market since its IPO, and it seems poised to continue its impressive run. Remember, Alphabet's growth estimates already outpace the market's historical growth rate. In other words, it could continue outperforming the market even if the stock's valuation remains unchanged.
But that's assuming everything goes well; a margin of safety can help protect you from being too optimistic. Alphabet hasn't been shy about repurchasing shares to help boot EPS growth, and the company's sitting on a ton of cash -- $113 billion, to be exact -- enough to retire nearly 10% of outstanding shares. Investors shouldn't anticipate management spending all their cash on repurchases, but it's an easy button to push to ensure bottom-line growth remains on track.
When you add it all up -- the growth outlook, the potential for share repurchases, and a valuation well below long-term norms -- it shouldn't take much to produce double-digit returns moving forward.
