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If You Buy Just 1 Stock, This Should Be It

By Andrés Cardenal - May 14, 2016 at 10:00AM

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This tech juggernaut looks remarkably strong in key areas such as business quality, financial performance, and valuation.

Image source: Google.

Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is the biggest position in my personal portfolio. My initial investment in the company dates back to 2009, and if I could buy shares of only one business right now, it would be none other than Alphabet. When looking at the company in terms of competitive strength, financial performance, and valuation, Alphabet looks like a remarkably strong investment to me.  

A rock-solid business
The company formerly known as Google changed its name and corporate structure last year in order to better reflect its business model. Alphabet is now a collection of businesses of which Google is the most important contributor, while the "Other Bets" segment includes several different projects and businesses such as Fiber, Nest, self-driving cars, Google X, and highly innovative healthcare initiatives such as Calico and Verily.

Google is the heavyweight champion in online advertising. The brand is so dominant that many consumers use the term "googling" as a synonym for online search, a privilege which only the most powerful brands in business history enjoy. Google owns an enormously valuable ecosystem featuring seven different properties with over 1 billion monthly users each: Google Search, Android, Maps, Chrome, YouTube, Google Play, and Gmail. 

The other bets segment includes investments in areas such as home connectivity, self-driving cars, outer space exploration, and futuristic healthcare technologies in areas like genetic mapping, among several other projects with intriguing potential. Many of these initiatives have limited commercial viability in the short term, however, when seen as a diversified portfolio of projects in highly disruptive technologies, they offer tremendous room for growth over the years and even decades ahead.

Impressive financial performance
Alphabet has a remarkable track record of growth over the years. Sales have increased at more than 20% per year in the last five years. Even as the business is gaining size, the company keeps producing vigorous growth: Total company-level sales grew 23% in constant currency terms during the first quarter of 2016.

The business model is remarkably profitable. Operating profit amounted to $5.3 billion last quarter, or 26% of revenue during the period. Even better, adjusted operating income, which excludes stock-based compensation and other non-cash expenses, was a staggering 34% of sales during the period. 

The company produced $5.2 billion in free cash flow during the quarter, and the balance sheet is as strong as it gets: Alphabet has over $70 billion in net cash, meaning cash and marketable securities net of debt. This means its financial soundness is unquestionable, and the company has more than enough financial resources to invest in all kinds of projects and initiatives.

A convenient price
Even the best companies can turn out to be mediocre investments if the price is excessively high, but that's not the case when it comes to Alphabet. Far from that, in fact -- the stock even looks attractively valued considering its business quality and financial strength.

Alphabet stock is trading at a forward price-to-earnings ratio in the neighborhood of 18, which is roughly in line with the average company in the S&P 500 index. Alphabet is no average company by any means, and it could easily justify a higher valuation due to its superior competitive strengths, growth potential, and profitability levels.

Similarly, when comparing Alphabet against other major players in online advertising, like social network Facebook (NASDAQ: FB) and Chinese search engine Baidu (NASDAQ: BIDU), the company looks attractively valued in terms of different valuation ratios such as forward price to earnings, price to earnings growth, and price to book value.

CompanyForward P/EPEGP/BV
Alphabet 17.9 1.8 4.1
Facebook 26.2 2.1 7.2
Baidu 19.8 3.5 4.9

Data source: SEC Fillings and FinViz.

The Foolish bottom line
Google provides undisputed competitive strength and huge profitability for Alphabet in online advertising, while the "other bets" segment is an intriguing portfolio of projects with extraordinary potential for growth and innovation over the long term. All this comes at a more-then-reasonable valuation, as Alphabet stock looks attractively priced in comparison to the average stock in the S&P 500 and also versus other online advertising players such as Facebook and Baidu.

Investment decisions need to be analyzed from multiple angles. When considering business quality, growth potential, and valuation, I believe Alphabet is truly an exceptional opportunity right now.

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
$2,240.15 (-3.30%) $-76.52
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
$160.68 (-5.20%) $-8.81
Baidu, Inc. Stock Quote
Baidu, Inc.
$153.79 (-0.93%) $-1.45
Alphabet Inc. Stock Quote
Alphabet Inc.
$2,251.43 (-3.47%) $-81.02

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

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