Summary
- GOOG was founded in 1998 and is headquartered in Mountain View, California (). It derives most of its sales from online advertising services.
- In this post we provide a simulation-based (sim-based) valuation () of GOOG.
- Our sim-based analysis suggests the following fair values – stock price: $3,385.97, and price-to-earnings (PE) ratio: 32.57. GOOG trades at $2,942.38, so it appears to be undervalued, with a potential upside of about 15%.
- GOOG’s leadership position in a few areas, and broad base of ventures with explosive growth potential, could lead to PE expansion, which would make our estimates above rather conservative.
Alphabet (GOOG)
GOOG was founded in 1998 and is headquartered in Mountain View, California (). It derives most of its sales from online advertising services, although other areas are growing at an accelerated pace. It breaks down its operations into three segments: Google Services, Google Cloud, and Other Bets.
Notable sources of revenue in the Google Services segment are hardware sales (e.g. the Pixel phone); and ads on Android, Chrome, Google Maps, Google Play, and YouTube. Google Cloud provides cloud infrastructure services, on which other (mostly third party) applications are run. The Other Bets segment could be seen as a very successful venture capital business.
Estimating a fair value for the stock
In this post we provide a simulation-based (sim-based) valuation () of GOOG.
At the time of this writing, the company had a profit margin of 30% and a price-to-earnings ratio of 28.3. The expected growth in earnings for the next 5 years is 30.09%, which is what we will use for the sim-based earnings growth rate. The table below summarizes our sim-based results.
Since our sim-based analysis uses a S&P 500 return as a basis, our results summarized on the table above suggest the following fair values – stock price: $3,385.97, and price-to-earnings (PE) ratio: 32.57. At the time of this writing, GOOG trades at $2,942.38, so it appears to be undervalued, with a potential upside of about 15%.
Final thoughts
Is inflation likely to become a problem for GOOG? We often hear from experts on business media outlets that inflation has a much more pernicious effect on growth stocks than value stocks. We looked into this issue in another post (). Our analyses suggested that growth stocks may do better under relatively high inflation (around 5%) than value stocks.
Moreover, GOOG’s leadership position in a few areas, and broad base of ventures with explosive growth potential, would allow it to: (a) raise its prices to make up for inflation; and (b) take advantage of the massive optionality generated by its Other Bets segment. Many other firms would not be in the same position, in part because the leaders in any industry are by definition only a few in number. All of this could lead to PE expansion, which would make our estimates conservative.
Finally, if the stock market experiences a correction, will GOOG shares go down? Mostly likely. In our view, that would be a buying opportunity.
Disclosure
The author owns GOOG shares at the time of this writing.
