Alphabet Stock Is a Buy After Split
Google’s dominance in search is unmatched, and YouTube should boost the top and bottom lines, says Morningstar’s analyst.
Alphabet GOOG/GOOGL dominates the online search market with 80%-plus global share for Google, via which it generates strong revenue growth and cash flow. We expect continuing growth in the company’s cash flow, as we remain confident that Google will maintain its leadership in search. We foresee YouTube contributing more to the company’s top and bottom lines, and we view investments of some of that cash in moonshots as attractive. Whether they will generate positive returns remains to be seen, but they do present significant upside.
We assign Alphabet a wide Morningstar Economic Moat Rating, thanks to durable competitive advantages derived from the company’s intangible assets, as well as the network effect. We believe Alphabet holds significant intangible assets related to overall technological expertise in search algorithms and machine learning, as well as access to and accumulation of data that is deemed valuable to advertisers. We also believe that Google’s brand is a significant asset; “Google it” has become eponymous with searching, and regardless of actual technological competency, the company’s search engine is perceived as being the most advanced in the industry. In our opinion, Alphabet’s network effects are derived mainly through its Google products such as Search, Android, Maps, Gmail, and YouTube.
Our fair value estimate is $169 per share, equivalent to a 2022 enterprise value/EBITDA ratio of 20. We expect margin pressure in 2022 as the firm continues to increase head count (albeit slowing down in the second half) and invest aggressively in growth. We look for margin improvement in 2024-26. Our model represents a five-year compound annual growth rate of 14% for total revenue and a five-year average operating margin of 26%.
Our Morningstar Uncertainty Rating for Alphabet is High, primarily the result of high dependency on continuing online advertising growth. While we remain confident that Google will maintain its dominant position in the search market, a long-lasting downturn in online ad spending could have a negative impact on Alphabet’s revenue and cash flow, resulting in a lower fair value estimate. On the other hand, positive returns on Alphabet’s investments in cloud and moonshots could increase our fair value estimate considerably.
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Ali Mogharabi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.