The average investor can find compelling investment ideas by looking at what the big boys are doing. Regulations require larger asset managers to disclose their holdings every quarter, which can provide valuable insights into potential stocks to buy.
One closely watched hedge fund manager is Bill Ackman, who has made a name for himself by making concentrated bets as the head of Pershing Square Capital Management. There's one business in particular that makes up a huge weighting in the fund.
As of Sept. 30, Ackman had 15% of its portfolio's assets (via a combination of two classes of shares) in one magnificent stock. Does this mean it's time for you to buy?
Bullish on an internet titan
In early 2023, Ackman and Pershing Square first started buying stock in Alphabet (GOOGL 0.75%) (GOOG 0.87%). The fund initiated a position when the tech giant's shares fell to an attractive valuation of a forward price-to-earnings (P/E) ratio of around 16. This was a historically cheap price to pay for what Ackman thinks is a world-class enterprise.
He highlighted several reasons for why making this investment was a no-brainer opportunity.
Alphabet benefits from the growth of digital advertising, with its dominant presence in the market. The company's industry-leading Google Search has unrivaled market share. And with YouTube, Alphabet has another avenue to sell digital advertising. Ackman thinks more money will move over from areas like TV and print ads to the company's advantage.
Cloud computing is another area that will drive growth for Alphabet. As businesses of all sizes see the need for greater off-premises IT capabilities, Google Cloud has another secular trend propelling it. This segment posted 35% year-over-year revenue growth and a 17% operating margin last quarter. Ackman wouldn't be surprised to see that margin start to approach what Amazon Web Services boasts, which is now over 38%.
NASDAQ: GOOGL
Key Data Points
Alphabet is one of the most financially sound companies on the face of the planet. As of Sept. 30, it had a net cash position of $80.9 billion. It also raked in $17.6 billion of free cash flow during the three-month period. This position allows management to aggressively buy back outstanding shares.
When it comes to artificial intelligence, very few businesses are in a better position than Alphabet. When OpenAI released ChatGPT about two years ago, the market initially was worried that it was the beginning of the end of Google Search. "We believe these concerns underestimate Google's structural leadership position in AI for several key reasons," Pershing Square's June 2023 letter reads.
Bill Ackman and his team think that because of its incredibly popular internet-enabled products and services, Alphabet has unmatched distribution. This gives the business an advantage when it comes to introducing new AI features for immediate adoption.
Additionally, Alphabet might have the biggest data repository to train AI models. And the company has been focused on AI for almost a decade, especially since current CEO Sundar Pichai took the top job in 2015.
Taken together, all of these positive attributes were critical to Alphabet entering Pershing Square's portfolio. And it remains the top holding.
Should you buy Alphabet stock?
Since the start of 2023, shares of Alphabet have catapulted 99% higher. This compares favorably to the Nasdaq Composite index's 84% total return during the same time. It's safe to say that Alphabet isn't as attractive an opportunity as it was when Ackman first started buying.
As of this writing, the stock trades at a forward P/E ratio of 21.9. This is clearly more expensive than a couple of years ago. However, it's still a reasonable entry point. And it makes Alphabet the cheapest stock among the "Magnificent Seven" group.
For prospective investors looking to buy a dominant business that's financially sound and that provides exposure to AI, Alphabet looks like a compelling option.
