Internet Content & Information company Alphabet is taking Wall Street by surprise today, falling to $96.97 and marking a -7.6% change compared to the S&P 500, which moved -0.2%. GOOG is -34.37% below its average analyst target price of $147.75, which implies there is more upside for the stock. Over the last year, Alphabet has underperfomed the S&P 500 by -13.1%, moving -28.3%.
Alphabet Inc. provides various products and platforms in the United States, Europe, the Middle East, Africa, the Asia-Pacific, Canada, and Latin America. The company is in the communication services sector, which includes primarily companies with a cyclical profile whose share price is correlated with macro economic cycles. The exception is large telecom companies, which are more defensive in nature since their share prices have a looser correlation with recessions.
Alphabet's trailing 12 month P/E ratio is 17.5, based on its trailing Eps of $5.55. The company has a forward P/E ratio of 16.7 according to its forward Eps of $5.82 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US communication services companies is 18.65, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
To better understand GOOG’s valuation, we can divide its price to earnings ratio by its projected five-year growth rate, which gives us its price to earnings, or PEG ratio. Considering the P/E ratio in the context of growth is important, because many companies that are undervalued in terms of earnings are actually overvalued in terms of growth.
Alphabet’s PEG is 2.3, which indicates that the company is overvalued compared to its growth prospects. Bear in mind that PEG ratios have limits to their relevance, since they are based on future growth estimates that may not turn out as expected.
An analysis of the company's gross profit margins can help us understand its long term profitability and market position. Gross profits are the company's revenue minus the cost of goods only, and unlike earnings, don't take into account taxes and overhead. Here's an overview of Alphabet's gross profit margin trends:
- 2021 gross margins: 56.9 %
- 2020 gross margins: 53.6 %
- 2019 gross margins: 55.6 %
- 2018 gross margins: 56.5 %
- Average gross margin: 55.6 %
- Average gross margin growth rate: 0.4 %
- Coefficient of variability (lower numbers indicating more stability): 2.7 %
We can see from the above that Alphabet's gross margins are very strong. Potential investors in the stock will want to determine what factors, if any, could derail this attractive growth story.
Companies have many costs that arise independently from their core business: cost of maintaining debt, rent payments, capital expenditures, depreciation, etc. When all of these separate cash flows are taken into account, we are left with the company's free cash flow, which for Alphabet was $67,012,000,000.00 as of its last annual report. This represents the amount of money that is available for reinvesting in the business, or for paying out to investors in the form of a dividend. With its strong cash flows, GOOG is in a position to do either -- which can encourage more investors to place their capital in the company. Over the last four years, the company's free cash flow has been growing at a rate of 43.5% and has on average been $40,914,750,000.00.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts). Alphabet's P/B ratio is 5.0 -- in other words, the market value of the company exceeds its book value by a factor of more than 5, so the company's assets may be overvalued compared to the average P/B ratio of the Communication Services sector, which stands at 2.62 as of the third quarter of 2022.
Alphabet is likely fairly valued at today's prices because it has a lower P/E ratio than the sector average, an elevated P/B ratio, and a steady stream of strong cash flows with an upwards trend. The stock has mixed growth indicators because of its consistently strong gross margins that are stable, and an above average PEG ratio. We hope this preliminary analysis will encourage you to do your own research into GOOG's fundamental values -- especially their trends over the last few years, which provide the clearest picture of the company's valuation.
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