Alphabet Inc. (GOOGL, Financial) (GOOG, Financial) has seen its share price more than double since October 2020. However, the stock is now down 14% from its highs due to general market volatility and inflation, which is lowering the purchasing power of Google’s monstrous $139.4 billion cash position. Let’s dive deeper into the company's financials and valuation following the recent decline.
Business model
Alphabet is a large tech giant that continues to dominate internet search with 85% of searches performed via Google. The company has a duopoly on the online advertising market with a 27% market share, along with Meta Platforms (FB, Financial), which was formerly known as Facebook. However, what differentiates Google from Meta is its dominance in search. It also owns the world's most popular web browser (Chrome at 64% market share) and the world's number one mobile operating system (Android), which has a 71% market share . This makes Google the backbone of the internet, giving it the ability to call the shots.
Advertising generates approximately 90% of Google’s revenue, but the cloud unit is the fastest-growing part of the business (44% revenue growth in fiscal 2021). Google Cloud is also the third-largest cloud provider (10% market share) behind Amazon's (AMZN, Financial) Amazon Web Services and Microsoft's (MSFT, Financial) Azure. Waymo, the self-driving vehicle business, was one of Google's “moonshot” bets, but is now fast becoming a reality. In Arizona, you can now hail a self-driving car via the Waymo One App. The company also recently announced the rollout of self-driving operations in San Francisco.
Growing financials
Alphabet’s financials are solid. The company brought in $257 billion in 2021, up 41% year over year. For a company of this scale, that is truly astonishing. Operating profit nearly doubled from $41 billion in 2020 to $78 billion in 2021, with a high 33% operating margin. The company also has a strong return on capital of 26% and return on equity of 32%.
The company’s balance sheet is a fortress and it has what I believe to be one of the largest cash positions on the planet, with $139.4 billion as of the fourth quarter of 2021. This large cash position has been criticized by many on Wall Street, but it does offer the opportunity for continued buybacks (over $50 billion).
Is the stock undervalued?
I have valued Alphabet using my advanced valuation model, which uses the discounted cash flow method . For my estimates of growth, I have 10% for next year and 8% for the next two to five years. I have also predicted the pre-tax operating margins will hold steady at 33%.
From this calculation, I get a fair value for Alphabet of $1.7 trillion, with a stock valuation (pre-split) of $2,649. The stock is now undervalued by approximately 4%. Relative to historic multiples, past financial performance and future earnings projections, the GF Value Line suggests the stock is fairly valued at these levels.
Conclusion
Alphabet is a tremendous company that is the true backbone of the internet. Google has a virtual monopoly on internet search and a strong core advertising business. The company's cloud business is growing fast and is expected to become profitable in the next several years. Its financial position is powerful and the company has what I estimate to be one of the largest cash positions of any global company.
The stock is currently trading slightly below its fair value, thus Alphabet could be an ideal company to park cash in as a long-term investment. However, should the stock pull back further, it will offer a greater margin of safety.
