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Alphabet Stock Looks Undervalued: Buying Opportunity?

By Andrés Cardenal - Apr 27, 2016 at 10:04AM

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Considering its quality and growth potential, the tech powerhouse is offering an attractive entry price for investors.

Image source: Alphabet.

Alphabet (GOOG 2.96%) (GOOGL 2.84%) is one of the most followed companies in the stock market. The tech giant has a leading presence in online advertising because of the ubiquity of its Google business. In addition, Alphabet is investing in exciting technologies such as self-driving cars, outer space exploration, and futuristic health-care technologies in areas like genetic mapping and glucose-monitoring contact lenses, among other intriguing projects with promising potential.

However, even if Alphabet attracts lots of attention from the media, it's easy to miss the forest for the trees when you're putting too much attention on the details. Looking at the big picture, Alphabet stock seems undervalued at current price levels, and this could present a buying opportunity for investors.

A top-notch collection of businesses
In August of 2015, the company formerly known as Google changed its name and corporate structure to better reflect its current business model and strategy. Alphabet is now a collection of businesses of which Google is the largest and most important contributor in terms of sales and earnings. The "other bets" segment includes several different projects and businesses such as Fiber, Nest, self-driving cars, Google X, and health-care ventures such as Calico and Verily, among others.

Google come second to none in online advertising. The company owns one of the most valuable brands in the world, and it has seven different platforms with over 1 billion monthly users: Google Search, Android, Maps, Chrome, YouTube, Google Play, and Gmail. The bigger it gets over time, the more information Google collects from users, which allows the company to improve the quality of its services and offer more effective ads. This means a bigger Google is also a stronger one, and the company has already reached a truly gargantuan scale.

The "other bets" segment includes several different businesses with little economic visibility in the short term. However, when seen as a diversified portfolio of innovative projects, they could do wonders for investors in Alphabet over the long term. After all, YouTube seemed like a moon shot project a decade ago, and it has now grown into an incredibly valuable platform. According to management, YouTube on mobile alone now reaches more 18- to 49-year-olds in the U.S. than any TV network, including both broadcast and cable TV.

Overall financial performance doesn't leave much to be desired. Total company-level revenue grew 17% during the first quarter of 2016, reaching $20.26 billion. Even better, sales in constant currency jumped 23% year over year, which is nothing short of impressive for a company that big. The business model is also remarkably profitable; Alphabet retained 26% of total revenue as operating profit last quarter.

Attractive valuation
According to data from Morningstar, Alphabet stock is trading at a forward price-to-earnings ratio in the neighborhood of 18, which is in line with the average company in the S&P 500 index. Considering that Alphabet is a market leader in the very promising online advertising industry, the company could easily justify an above-average valuation on the back of superior profitability and potential for growth.

The following table compares valuation ratios for Alphabet against other companies in online advertising, such as Facebook (FB 3.86%) and Chinese search engine Baidu (BIDU 8.40%). The main idea is quite clear: When looking at forward price to earnings, price to earnings growth, price to sales, and price to book value, Alphabet looks conveniently priced in comparison to peers.

CompanyForward P/EPEGP/SP/BV
Alphabet 18.2 1.9 6.5 4.3
Facebook 26.4 2.5 17.9 7
Baidu 21.4 3.8 6.4 5.3

Data sources: SEC filings and FinViz. 

Both Facebook and Baidu are much smaller than Alphabet in terms of revenue, and this could make it easier for these companies to sustain rapid growth, since performance tends to slow down as a company gains size over the years. Nevertheless, even if Facebook and Baidu could outgrow Alphabet in the middle term, Alphabet is strong enough to retain its position as the undisputed leader in online advertising for years to come. 

Valuation is not just about the price tag; you need to consider valuation ratios in the context of the company's fundamental quality and long-term potential. Alphabet is a world-class business making tons of money via Google in online advertising and offering exciting opportunities for disruptive innovation in "other bets." All things considered, current valuation levels are offering an attractive entry price for investors in Alphabet.

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$2,321.01 (2.84%) $64.13
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
FB
$198.62 (3.86%) $7.38
Baidu, Inc. Stock Quote
Baidu, Inc.
BIDU
$116.94 (8.40%) $9.06
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOG
$2,330.31 (2.96%) $67.09

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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