There are generally two popular ways to invest in the stock market. Growth investors look for businesses that are usually increasing their sales at a rapid clip. Value-focused investors, on the other hand, look for stocks that are trading for cheap prices relative to competitors and their own fundamentals. Legendary investor Warren Buffett has made a successful career by focusing on the latter.
Speaking of value investing, after the S&P 500 and the Nasdaq Composite Index dropped 19% and 33%, respectively, in 2022, there are certainly some attractive investment opportunities out there that are on the cheaper end of the spectrum. And you don't have to sacrifice business quality to own them.
Here's why Alphabet (GOOGL -1.97%) (GOOG -1.96%) is my top value stock to buy right now.
Looking at the P/E ratio
To quickly assess the valuation of a specific company, investors can look at the popular price-to-earnings (P/E) ratio. This measures a stock's price relative to its earnings per share. A lower P/E multiple, all else equal, is a good sign because it could indicate the stock is undervalued. To be clear, this method can't work on businesses that don't have any profits.
As of this writing, Alphabet shares are off 39% from their peak set in November 2021. As a result, the stock currently trades at a P/E multiple of 20. This is well below the stock's trailing three-, five-, and 10-year valuation averages. What's more, it is lower than the valuation of the Nasdaq 100 Index.
Why has the stock been under so much pressure lately? Alphabet boomed during the coronavirus pandemic, and its stock price climbed quickly, rising 180% from the COVID low to its peak in late 2021. But once the market realized that the decades-high inflation numbers weren't transitory, and that interest rates were set to rise, investors completely soured on tech stocks. This hurt Alphabet's share price.
We can also point to weakness in the digital advertising market. As executives prepare for a recession, they can quickly cut their marketing dollars. Since the bulk of company revenue comes from advertising, Alphabet felt the pain. Growth decelerated throughout 2022, with sales rising just 1% year over year in the fourth quarter.
Alphabet hired aggressively over the past few years, and so it probably wasn't a surprise when the company announced layoffs of 12,000 employees in January. And Chris Hohn, a prominent hedge fund manager, late last year called on Alphabet to lower its costs.
What should give shareholders confidence in Alphabet's prospects is that I believe these issues are temporary. They aren't necessarily specific to this company, as we've seen numerous businesses out there struggle throughout 2022. Once the economic picture turns positive and the digital advertising market bounces back, Alphabet should be back to its usual self.
Still a great business
It's worth zooming out and focusing on the big picture, instead of fixating on the near-term headwinds. Alphabet benefits from thriving business lines. Accounting for 56% of overall company revenue in the fourth quarter of 2022, Google Search is undoubtedly Alphabet's bread-and-butter segment. It commands 93% of the global search market. And as more internet usage happens on mobile devices, coupled with the fact that roughly one-third of the people in the world haven't used the internet, traffic and sales are likely to rise at a healthy clip over time.
YouTube is another part of Alphabet that is hard to ignore. The video entertainment service generated $29.2 billion in ad revenue in 2022 (excluding subscription services), nearly on par with Netflix's $31.6 billion. YouTube is special because, like Google Search, it benefits from network effects. More content attracts more viewers, and vice versa, making the service constantly better.
Lastly, investors need to know about Google Cloud Platform (GCP). With $26.3 billion in revenue in 2022, which was up 37% year over year, GCP is third only behind Amazon Web Services and Microsoft Azure. What's promising is that the operating loss in this segment shrank on a quarter-over-quarter and year-over-year basis in the most recent three-month period. The hope is that with greater scale, GCP can be an important profit driver for Alphabet.
Being a value investor doesn't mean the companies you own must be mediocre. In fact, they can be some of the best businesses in the world. Alphabet proves this.
