The company may be called Alphabet (GOOGL +2.53%)(GOOG +2.83%), but ask most people what comes to mind first when the company is mentioned and Google will be their response. Google and its search engine are a force in the world (91% market share globally) and it has become so ingrained in our culture that Webster's includes official words in its dictionary like "Googled," "Googling," and even "Googleable." No words related to the search engine Bing have made Webster's cut (sorry, Microsoft).
But there is much more to this company than just Google. It's part of the reason management changed the company name back in 2015.
Here are four things that smart investors should know about this tech giant.
NASDAQ: GOOGL
Key Data Points
1. Google Search dominates, but its competition is growing
Google Search provides a ton of Alphabet's revenue -- $44 billion last quarter, which is 57% of total sales. An astonishing 90% of all searches use Google. However, the advancements in artificial intelligence (AI)-powered chatbots, like OpenAI's ChatGPT, provide real challenges.
After more than a decade Where Google was the go-to search engine, it looks like the way people gather information may be about to change. If you haven't tried ChatGPT or Perplexity.ai, give them a try. What they offer is pretty incredible. This doesn't mean that Alphabet will lose out, though. The company has plans of its own.
First, even when I use a competing chatbot like Perplexity, any source I click on opens in my default browser -- Google Chrome. Alphabet is also developing its own generative chatbot named Bard. Bard integrates with other Google applications, like Maps and YouTube, to enhance the usefulness of results and feed the company's ecosystem. Alphabet introduced Assistant with Bard recently. This app will act as a personal assistant to users who can interact with it through voice, text, and images. Google DeepMind is the team dedicated to developing everything AI for Alphabet.
It can't be stressed enough how critical Search is to Alphabet. Investors should watch how well Alphabet competes in this evolving arena.
2. Alphabet is a cash-producing force
Cash flow is the ultimate measure of any business, much more than net income. After all, two companies can have the same net income, but one can have much better free cash flow (FCF) if it spends less on property and equipment (aka capital expenditures or "CapEx"). Net income also contains non-cash items like depreciation and other accounting adjustments. At the end of the day, the business owner wants cash in their pocket -- this is why I look to cash flow first.
As shown below, Alphabet is a cash-making juggernaut.
GOOGL Cash from Operations (TTM) data by YCharts.
Over the past 12 months, the $106 billion in cash from operations (CFO) and $78 billion in FCF make up 36% and 26% of revenue, respectively. These impressive margins have significant implications. First, this allows Alphabet to invest heavily in research and development, creating applications like Bard. Second, the company rewards shareholders with stock buybacks, $45 billion so far in 2023. Finally, Alphabet has a fortress balance sheet with $114 billion in cash and investments against just $15 billion in long-term debt. These are all signs of a very healthy business.
3. YouTube and Google Cloud are vital growth avenues for Alphabet
YouTube ads and Google Cloud are vital pieces of Alphabet's business, combining for $16 billion or 21% of sales last quarter. These two segments have accounted for tremendous growth over the last few years, as depicted below.
Data source: Alphabet.
Alphabet is making a large push to compete with TikTok through YouTube Shorts. The company reported 70 billion daily views last quarter. Google Cloud is the third-largest global cloud services provider, behind Amazon Web Services (AWS) and Microsoft Azure. The cloud will likely grow significantly due to AI, Google Workspace, and its cybersecurity offerings. Keep a close eye on growth in these segments.
4. Alphabet stock is undervalued compared to historical averages
The fourth piece of the puzzle is Alphabet stock's valuation. The stock price is up nearly 40% this year after a dismal 2022 for the market; however, several key metrics show it as still historically undervalued. When measuring the price against cash from operations per share or free cash flow, the stock is 8% to 26% undervalued based on five-year averages, as shown below.
GOOGL Price to Free Cash Flow data by YCharts.
I always look to cash-flow measures, as I said above. The stock also trades at slightly under its five-year average price-to-earnings (P/E) ratio at 26.
The long-term success of Alphabet stock will ultimately rest on management's ability to compete with the next generation of search, manage capital, and continue the growth of the other segments. Given the health of the business and its history of success, Alphabet stock looks very tempting for long-term investors.
