The price to earnings (P/E) ratio is arguably the most popular financial metric because it shows the price of a stock relative to its trailing-12-month earnings. It's straightforward, though sometimes inaccurate when dealing with a small company, or when a one-time windfall or impairment charge makes a stock more or less expensive.
However, the P/E ratio of the S&P 500 is an excellent barometer of the stock market's valuation, because it considers the earnings of all S&P 500 companies. The current S&P 500 ratio is 27 -- around the highest the market has traded in 15 years if you factor out the COVID-19-induced spike, which occurred because earnings temporarily plummeted for many companies.
Value-oriented investors will look at the market's valuation and want to run for the exits. But the market is forward-looking. And right now, it sees a lot of growth potential through a resilient overall economy powered by lower interest rates, lower inflation, and the long-term impact of artificial intelligence (AI).
Here's why Alphabet (GOOG 9.96%) (GOOGL 10.22%) blends growth and value, and is a growth stock worth buying now.
Image source: Getty Images.
The most affordable Magnificent Seven stock
The "Magnificent Seven" is a term used to describe the seven largest tech-oriented companies -- Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta Platforms, and Tesla. Yet Alphabet is the only one with a P/E ratio below that of the S&P 500, not to mention it has the lowest ratio of price to free cash flow (P/FCF) in the bunch.
GOOG PE Ratio data by YCharts
Alphabet's discount to its Magnificent Seven peer group, let alone the S&P 500, may seem strange; it's a large, diversified company with a track record for implementing AI-based solutions and generating tons of free cash flow, which fuels further growth and stock repurchases.
There are many theories about what's holding Alphabet back. But the simplest may be a lack of perceived growth relative to its peer group.
Apple is in a similar boat. Despite its dominant vertical integration and wide moat, it simply isn't growing its top or bottom line at the pace investors have come to expect. That's why Apple is the second-cheapest Magnificent Seven stock based on both P/E and P/FCF.
Alphabet is in a difficult spot
Alphabet's core growth drivers are its search engine (Google), Google Cloud, and YouTube. Alphabet has been monetizing AI for decades. But the market is forward-looking and seems to think that other companies have more potential growth than Alphabet. To some extent, that's true.
Alphabet and Meta are the top dogs in the advertising space. But over the last year, Meta has grown revenue and net income faster than Alphabet:
GOOG Revenue (TTM) data by YCharts.
According to Statista, as of the fourth quarter of 2023, Google Cloud holds an 11% share of the cloud infrastructure market. However, that's far behind Microsoft Azure at 24% and Amazon Web Services at 31%.
Alphabet's generative AI answer to ChatGPT is Gemini, formerly known as Bard. But even that solution is less proven and has less of an immediate impact than ChatGPT.
Microsoft's partnership with OpenAI gives it the leading product in the space right now. And Microsoft arguably has a better business than Alphabet for monetizing AI-based solutions. From Azure OpenAI to Microsoft Copilot for Office products, Microsoft Edge, and GitHub, Microsoft has several different avenues for deploying AI across enterprise customers and consumers. It is arguably the greatest sandbox for trying things out and seeing what sticks.
All told, Alphabet has the AI muscle to go toe-to-toe with anyone, but it lacks the breadth or market positioning (in the cloud market) of some of its peers. After all, Alphabet has been using AI to enhance its search engine optimization for decades. But that story is already told. Investors are looking for the next chapter, and Alphabet simply doesn't have as clear of a leading role as Microsoft and other players.
Alphabet is discounted for a reason
Alphabet's discount to the rest of its peer group is justified. It doesn't have quite the value of Apple, the growth-value hybrid of Meta Platforms, the AI runway of Microsoft, the pure growth of Nvidia, or the cloud dominance of Amazon.
However, there's no reason Alphabet should trade at a discount to the S&P 500. Alphabet may not be the most exciting Magnificent Seven stock out there. But it's still a cash cow with plenty of capacity to fuel ideas and develop solutions with breakout potential.
Alphabet's valuation makes it a relatively low-risk way to dip your toes into the Magnificent Seven, without the risk of a severe valuation correction facing a stock like Nvidia.
