Bill Nygren (Trades, Portfolio) has enjoyed a lengthy and successful career as an investment manager. Having helmed a number of Oakmark Funds’ mutual funds for decades, Nygren has developed a reputation as a seasoned and skillful value investor. His advocacy of value-oriented strategies is hardly unsurprising, given Oakmark’s stated investment philosophy:
“At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.”
Yet, while he still adheres to his philosophical roots by and large, Nygren has also advocated for an expansion of the definition of what a value stock is. Case in point: Nygren believes that Alphabet Inc. (GOOG, Financial) (GOOGL, Financial) should be considered a value stock.
Not your average value stock
At first glance, Alphabet could hardly be called cheap by any conventional definition. The tech giant currently trades at about 30 times earnings. With a market capitalization of more than $900 billion, it is one of the most valuable publicly traded companies in the world. Yet, this has not deterred Nygren one bit, as he told Barron’s in a Dec. 13 interview:
“One of the ways we differ from some value investors is that we acknowledge that we have moved to more of an asset-light economy than the heavy industrial economy I grew up in. We are very willing to look at companies that look expensive on [traditional] metrics.”
Despite its wide popularity (both as a service and a stock), large analyst following and premium valuation, Nygren thinks Alphabet Inc. is cheap. How can that be?
Core search business undervalued
Alphabet is made up of a number of businesses, but the beating heart is still its search engine, Google.com. According to Nygren, Alphabet is undervalued based solely on its search business:
“[Search is] worth a significant premium to the market multiple. Yet we’re paying less than a market multiple to own the search business. At that price, Alphabet’s just too cheap.”
While by far its largest source of income, Google is far from Alphabet’s only earning asset. In its earnings reports, Alphabet reports aggregated advertising revenues, including those from Search, Maps, Gmail, YouTube, Play Store and Shopping. Alphabet has enjoyed years of healthy advertising revenue growth thanks to the dominance of Google as a search platform.
While its prodigious ad revenue includes other platforms besides Search, Nygren is confident that Alphabet, even netting out revenue from YouTube, could justify its current price of about $1,350 per share.
Adding in YouTube and cash
In the second quarter of 2019, Google and its properties (including YouTube) generated $32.6 billion in advertising revenue, up 16% year-over-year. In the third quarter, the search engine yielded $33.9 billion in revenue, up 4% sequentially and up 17% from third-quarter 2018.
Nygren sees YouTube as especially valuable, and does not believe this value is reflected accurately in Alphabet’s current share price:
“Then you look at YouTube, which has the most video programming viewed of any video service out there. You could get a YouTube number north of $400 a share.”
Nygren estimated that YouTube alone should be worth more than $400. Add in the $150 in net cash per share on Alphabet’s books, and Nygren’s implied valuation of Alphabet as a whole climbs to about $1,900 per share, implying more than 40% upside.
But that is not all that Alphabet owns or has to offer. Indeed, the company’s other ventures have also caught Nygren’s appraising eye.
Don’t forget the venture capital
For years, Google (as Alphabet was originally known) had been exploring various business ventures and engaging in extensive in-house and corporate venture capital activities. In 2015, this culminated in the reorganization of the company into a conglomerate, with Alphabet Inc. functioning as the parent company to Google, as well as a host of other businesses, such as autonomous driving startup Waymo. Nygren believes these venture capital activities should be better reflected in Alphabet’s share price:
“You look at their venture-capital-like investments [such as] Waymo. You look at the valuations for General Motors’ ownership in Cruise, or Intel’s purchase of Mobileye, and you see there is obviously very, very significant asset value inside of Waymo. We think you’ve got another $100 to $200 a share of business value.”
The values of autonomous vehicle companies have exploded over the past couple years as many big tech and auto players have scooped up impressive startups to support. With so many analysts and commentators speaking breathlessly of a future in which AVs predominate, it is perhaps no surprise that Nygren would see significant value in Waymo.
Taken together, Nygren’s sum-of-the-parts analysis would suggest a minimum intrinsic value of $2,000 per share, a 48% premium to the prevailing share price. While Nygren makes a decent case that Alphabet’s cash and non-Google assets are undervalued, taken as a whole it is still difficult to accept that this company trading at 30 times earnings could be considered cheap.
Moreover, Nygren’s high valuation of Waymo is somewhat suspect. While AV technology may prove highly valuable one day, it is still many years from fruition. Assigning multi-billion-dollar valuations to such speculative enterprises is a dubious business.
Overall, while Alphabet may not be heinously overvalued, I myself am not prepared to call it a value stock.
Disclosure: No positions.
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