Could Alphabet stock be a value trap?
One of the things successful investors do is honestly assess the bear case on shares they own. Take my recent investment in Google parent Alphabet (NASDAQ: GOOG), (NASDAQ: GOOGL) as an example.
While I am very bullish about the long-term outlook for Alphabet stock, it has fallen further since I bought it. The shares are now 33% below their level a year ago. With a market capitalisation of over $1tn, the company is priced for a very high degree of future success, which is not guaranteed.
Could it be a value trap?
One of the reasons behind the fall over the past year is investor concern about what Artificial Intelligence (AI) might mean for the future of search. This has been catalysed by the release of the ChatGPT product. However, it has been brewing as an issue for years.
Currently, Google makes a lot of money when people spend time using its search services and are fed adverts along the way. But if AI is able to serve up relevant content without the user even needing to search for it, the amount of advertising impressions served could plummet compared to traditional search. That could be very bad news for Alphabet, which remains heavily reliant on ad revenues.
Even aside from these strategic questions there is the more immediate one of whether economic weakness in many markets will hurt ad spend – and Alphabet’s revenues. In its most recent quarter, the business reported year-on-year revenue growth of just 1%.
Over the economic cycle, as a long-term investor I expect global advertising spend to be robust. That money has to be spent somewhere – and Alphabet has shown over the past couple of decades that it is able to attract such spend and provide solutions advertisers want.
Along the way it has already adapted to dramatic shifts in technology. When Google started, for example, the iPhone had not been invented. That gives me confidence that Alphabet will be able to use its skilled workforce, infrastructure and commercial sensibilities to navigate a changing world.
Such assets are actually part of another risk I see for Alphabet though. It is huge – and hugely profitable.
Just as we saw with Microsoft several decades ago, I expect Alphabet to become a growing target for regulators who want to stop it becoming too powerful.
That might mean parts of the company are broken off. That will not necessarily be bad for owners of Alphabet stock however. After all, if the firm was forced to restructure, they should still own the sum of the parts.
It is over a century since Standard Oil was forced to break up. Its shareholders who kept the stock they got as a result (including Exxon) have done phenomenally well!
There are risks here, clearly. But Alphabet has strong competitive advantages. Its addressable market is vast and growing. Its own user base is massive. And they have reasons to stick with what they know and use already.
The company has a unique advertising ecosystem that continues to churn out huge earnings. Last year, net income fell – but was still $60bn.
With a price-to-earnings ratio of 20, I see Alphabet stock as good value. That is why I have been buying.
The post Could Alphabet stock be a value trap? appeared first on The Motley Fool UK.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. C Ruane has positions in Alphabet. The Motley Fool UK has recommended Alphabet and Microsoft. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2023