The Valuation Argument for Owning Google (NASDAQ:GOOG) (NASDAQ:GOOGL)

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My latest article on search, streaming, and cloud giant Alphabet/Google (NASDAQ:GOOG) (NASDAQ:GOOGL), published in July here, discussed its monstrous cash holdings and free cash flow generation. Of course, the wicked 2022 tech selloff brought down all related Big Tech names, regardless of long-term prospects and projections. Shares are down another 20% since late summer as bearish attitudes in the sector are now overwhelming all math and logic. To me, the buy proposition is even better than it was six months ago and the future upside (compound potential) for investors continues to improve.

Today I want to discuss the 10-year low valuation for Google. The good news is that this entry level lowball for investors is still backed by the best balance sheet in the large-cap space on Wall Street. Plus, huge profit margins criss-cross with decent growth potential, despite a stock market cap of over $1 trillion.

Its diverse business range was built using cash flow generation from the world’s leading search engine to fund new ventures. Another successful, high-growth monster has been developed through its YouTube media streaming division, as a second-largest profit center revenue rival that rivals Netflix (NFLX) and Disney (DIS) for online entertainment leadership . Additionally, Google Cloud is now one of the best online download and storage services, ranked alongside offerings from Amazon (AMZN), Microsoft (MSFT), and International Business Machines (IBM).

Diversification of business units and customer locations (53% outside of America for fiscal 2022) provides levels of security and stability for revenue and revenue as the US economy slows or enters a recession this year year.

Alphabet/Google 10-Q for September 2022

Alphabet/Google 10-Q for September 2022

Sure, owning “the” strongest balance sheet in the major US conglomerate sector is worth it, especially if you can buy Google’s core assets in the bargain bin. Below is a chart examining cash and short-term investments of $116 billion at the end of September compared to a total financial debt of just $13 billion.

YCharts – Alphabet/Google, cash vs. total debt, 10 years

Compared to other names in Big Tech plus major healthcare, energy/oil and diversified holdings in the mega-cap space, Google stands out as the most conservative and financially flexible company of them all! The following sort list includes Meta Platforms (META), Apple (AAPL), Berkshire Hathaway (BRK.A) (BRK.B), NVIDIA (NVDA), Advanced Micro Devices (AMD), Intel (INTC), Tesla ( TSLA), Johnson & Johnson (JNJ), Microsoft, Amazon and Exxon Mobil (XOM).

YCharts – Alphabet/Google vs. Mega-Cap Peers, total debt less cash, 10 years

Low rating at 10 years

The main reason I continue to like Google as an investment and am willing to hold onto temporary losses is that investors seem to have given up on the business. Why is that a good question? The long-term outlook for targeted search revenue, eyeball streaming advertising, as well as moving our tech-based world to the cloud remains fairly optimistic.

I know that growth rates in the next decade will not be the same as in the recent past. However, Google/Alphabet has huge cash balances and comes in daily to invest in new business units (organically or through acquisitions) or even aggressively buy back existing stock (ownership units) to help accretively drive results. In a downturn, other companies won’t be able to take advantage of the downturn in a similar way.

Final income margins on sales are above normal compared to the largest cap companies in America. In fact, only Microsoft has a higher net margin rate of 34% compared to Google’s 24% over the last 12-month period.

YCharts – Alphabet/Google vs. colleagues Mega-Cap, final income margins, 10 years

Ultimately, I don’t understand the logic of putting 10-year operating multiples on the business. Below is a breakdown of the relationship between price and underlying fundamental fundamentals for Google. On earnings, sales, cash flow, and tangible book value, it appears Wall Street is super bearish on both the company’s present and future.

YCharts – Alphabet/Google, from price to basic end fundamentals, 10 years

Even more striking is the enterprise value of the company relative to underlying EBITDA (ground floor cash generation) or revenues. When we subtract 10% of the company’s value to account for the $103 billion in net cash it holds (not needed to run the business), a much clearer business argument appears.

Based on the EV calculations below, Google is 30% off its 10-year averages and more than 50% off its 2021 peak valuation. Bottom line, back to the same enterprise value multiples of late 2021, the stock price is expected to DOUBLE to $180 (as the underlying asset continues to grow, albeit at a slowing pace).

YCharts – Alphabet/Google, EBITDA and sales from EV to Trailing/Forward, 10 years

Again, when we look at EV multiples to projected forward EBITDA, Alphabet/Google is rated as one of the “cheapest” Big Tech and large-cap companies in America. The current 8.5x ratio is an approximate 30% discount to the median mean of our sorting group. Does it make sense for one of the highest-margin companies with the best balance sheet and strong growth prospects to be valued at the low end of the spectrum? My answer is a hard NO. Logically, the opposite should be the reality. Essentially, Google could easily be priced at higher than normal rates against the alternatives.

YCharts – Alphabet/Google vs. Mega-Cap Peers, from EV to forward EBITDA, from 2021

Technical considerations on trading

Unfortunately for shareholders, total returns over the past year have been a sizable -37% loss, drawn below. Luckily for shareholders, this number vastly outnumbered other Big Tech picks. Most peers’ 2022 losses range from -50% to -90% (many not pictured) for total returns. So, Google’s owners don’t have much to complain about, especially if the price returns to all-time highs later in 2023 or 2024.

YCharts – Alphabet/Google vs. colleagues Mega-Cap, total investment returns, 12 months

On the technical momentum front, I would like to have positive news to report. Of my favorite Quantum list of 10 indicators, only a few show any kind of bullish activity. Perhaps the smartest combination of indicators for bulls is drawn below.

Google was able to outperform competitors and Big Tech competitors over 1 and 2 year periods. Over 2 years, total returns exceeded Invesco’s NASDAQ 100 ETF (QQQ) by 10%.

The best indication of a potential immediate price bottom is found in the relative action of the 14-day Money Flow Index versus the 14-day Average Directional Index. MFI oversold conditions with a score of 30 (circled in blue) coinciding with a low volatility ADX score below 15 (circled in green) have been rare. Today’s instance is similar to the January 2021 and January 2022 setups. Marked by the green arrows for price, the latter two circumstances turned out to be decent to great times to buy Google for a multi-month trade. Will history repeat itself this January and help investors gain in February and March?

StockCharts.com – Alphabet/Google, daily price and volume changes, author’s landmarks, 2 years

Final thoughts

While the momentum picture is not very bullish, I view the current price below $90 as Strong Buy territory. If Google’s share falls further in the coming weeks, I’ll probably increase my stake. Eventually, investors will return to the stock. When they do, the price could rapidly increase by 30% to 40%. That would only return the valuation story to 10-year normal levels (an average reversal effort), as operating results continue to climb. If an economic rebound occurs in the second half of the year, pushing sales and income higher than expected in 2024, a share increase of more than 50% is likely in the next 12 to 18 months. At least that’s how I see it.

What are the investment risks? The main concerns are a deep recession further hurting advertising trends and a continuing equity market downturn through the year. Both are risks that should be seriously considered, as the odds of both playing are high (between 25% and 50%, in my opinion). Other risks revolve around antitrust actions in Europe, the US and elsewhere. Governments would like to regulate the near monopoly on search engines and might even try to break the business into three or more separate companies. I personally believe that today’s undervaluation may already be pricing in such stocks, to some extent.

My view is that buying this blue-chip winner on weakness will pay off over time.

I put the odds of the price falling below $70 a share in 2023 (20% loss from $87) at less than 1 in 10 probability. Against the potential for earnings above 50% best case over the next 12 months , the playing field could be tilted heavily in favor of the bulls.

Seeking Alpha’s Quant Ranking system now ranks a Top 8% on Google against alternative stock picks. Still growing operating results and an improving valuation are generally positive developments for investors.

Seeking Alpha – Alphabet/Google Quant Rank, January 6, 2022

Google is truly a top 10 company in the US as measured by a variety of metrics such as balance sheet strength, profit margins, raw size and scope, employee compensation, customer satisfaction, etc. If you want to participate in the future of the US stock market, owning this blue-chip media/tech at an unreasonably low valuation is something of a no-brainer in portfolio building.

Thanks for reading. Consider this article as a first step in your due diligence process. It is recommended that you consult a registered and experienced investment adviser before placing any trades.

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