Recently, Apple (AAPL 0.04%) lost its title as the world's largest company to Microsoft (MSFT +1.69%). However, there's another business lurking behind these two that could feasibly be worth more than either: Alphabet (GOOG +0.05%) (GOOGL 0.04%). It's one of the world's most profitable companies, and produces an unreal amount of earnings. However, it doesn't have the premium valuation that those two do.
So, if the market decided to snap its fingers and value these companies at the same level tomorrow, Alphabet could be the world's most valuable company. But is there a good reason for the pessimism?
Image source: Getty images.
Alphabet doesn't have a premium valuation
If you look at the valuations, Alphabet is clearly valued much lower than its big tech peers.
GOOGL PE Ratio data by YCharts; PE = price to earnings.
This is despite generating far more net income over the past year.
GOOGL Net Income (TTM) data by YCharts; TTM = trailing 12 months.
There are a few factors at play for Alphabet's cheap valuation. First, its business is primarily advertising. In the first quarter, $61.6 billion of its $80.5 billion in revenue came from advertising-related sources. The market views this as a potential liability, as advertising budgets tend to get cut during an economic downturn.
Considering that the U.S. economy may be on the doorstep of one, the market is taking no chances and is not a rabid buyer of the stock. Even during an economic boom, there's still that sense of danger in the back of investors' minds that the good times don't last forever, which is why Alphabet rarely has a huge premium attached to its stock.
Still, Alphabet's situation is hardly different from that of Apple, as Apple relies on sales of consumer electronics. Its devices aren't the cheapest around, and an economic downturn could push consumers to cheaper alternatives or cause them to delay purchases. As a result, Apple is just as vulnerable to a downturn as Alphabet, so its premium doesn't make a ton of sense, at least from that standpoint.
Microsoft has a slightly stronger business model, especially with its heavy reliance on cloud computing and business software. While it may see its growth slow down, it's unlikely to lose many sales, unlike Alphabet and Apple. So, Microsoft likely deserves a more premium valuation than these two. But double Alphabet's valuation seems a bit absurd.
Still, there's one more factor investors must consider with Alphabet stock.
NASDAQ: GOOGL
Key Data Points
Alphabet is facing a potential breakup by the U.S. government
Alphabet's business dominance hasn't gone unnoticed. A U.S. district judge found Alphabet guilty of operating an illegal monopoly in its search engine and ad platform business. As a result, the Department of Justice recommended that Alphabet be forced to sell its Google Chrome browser. However, this is a long way from becoming a reality since the case is likely to end up at the Supreme Court before it's finished.
This is another factor weighing on Alphabet shareholders, because they don't know if the business they're investing in now will still be intact in five years due to its dominance. This is a real concern, and a much more valid one than worrying about its ad business.
However, a broken-up Alphabet may unlock shareholder value, which could boost returns. Furthermore, there's no guarantee that a breakup will actually occur, and if it doesn't, it will remain in its incredibly dominant state, but with some more regulatory guardrails to keep it from achieving the same level of dominance.
I think there's enough value in the stock to buy it now, because its absurdly low valuation isn't justified by the market's fears about it. There are very few opportunities to buy stocks this cheaply, and investors should waste no time loading up on Alphabet shares.
