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Alphabet: Focus on Operating Profits, Buybacks
Stock Analysis & Ideas

Alphabet: Focus on Operating Profits, Buybacks

Alphabet (GOOGL) is the third highest-valued company in the world, boasting a market cap of $1.5 trillion.

The parent company behind Google search, Youtube, Weymo, and several other ventures has seen its shares suffer dramatically over the past few months.

However, unlike many growth equities, which had been trading at extremely high multiples, Alphabet has gone from reasonably valued to quite cheaply valued during the ongoing sell-off.

Alphabet’s most recent results demonstrated that the company remains a double-digit-growing cash cow, with a pristine balance sheet and skyrocketing capital return prospects.

While the market action during extended hours following the report suggests that the street was mostly unimpressed with the numbers, I believe that Alphabet is very attractively priced for investors looking to accumulate shares for the long term. Thus, I remain bullish on the stock.

Q1 Results

Alphabet’s Q1 results came in quite strong. The company topped analysts’ revenue estimates by $140 million to reach $68 billion, 23% higher year-over-year. Revenue growth was led mainly by Search and Cloud.

Specifically, total Google Services, which basically refers to the advertising business across all platforms, reported revenues of $61.5 billion, up 20.1% compared to last year. The increase was driven by higher consumer search volumes and continuous recovery in travel.

YouTube also performed well, with its advertising revenues reaching $6.9 billion, up 14.4% year-over-year. While YouTube’s growth implies a deceleration from the previous quarter’s 25.4%, two important points are to be recognized.

Firstly, the deceleration in growth compared to last year largely images the lapping of the outstanding performance of YouTube’s “Direct Response” ads that Alphabet called out in Q1 2022.

Secondly, nowadays, a growing number of platforms compete brutally for consumers’ limited watch time. Hence, it’s quite remarkable that YouTube continues to grow at a double-digit pace.

During the earnings call, management mentioned that YouTube Shorts is now averaging over 30 billion views per day, a 4x increase compared to last year. This is quite impressive, especially when we consider the rise of TikTok’s popularity over the past year.

Further, despite the company’s continuous investments in products, services, and talent, including the headcount growing 17.1% year-over-year to 163,906 employees, the operating margin remained robust at 30%.

Thus, operating profits grew 22.2% to $20 billion. This is important to note because Alphabet’s profitability actually grew once again despite net income coming in 8.3% lower year-over-year to $16.4 billion.

The decline was due to a non-cash “expense” reflecting a loss of $1.2 billion, resulting from unrealized losses in the value of Alphabet’s equity investments amid the ongoing market volatility, and not due to actual outflows.

Capital Returns, Valuation

Over the past few years, Alphabet has been accelerating its stock repurchases, which has been the company’s preferred way to return capital to shareholders.

Last year, the company repurchased $50.2 billion worth of stock, up substantially from the previous year’s $31.1 billion. In Q1 of this year, Alphabet continued to boost its stock repurchases, buying back $13.3 billion versus $11.4 billion in Q1 2021.

Further, management announced that the BoD has now authorized the company to repurchase up to an additional $70 billion of stock. Based on the current trajectory of stock repurchases, I wouldn’t be surprised if they exceeded $65 billion this year, which implies a “buyback yield” of just over 4% at the stock’s current price levels.

It makes sense, after all, assuming that management will take advantage of the stock’s current valuation to retire shares on the cheap.

Speaking of which, analysts expect Fiscal 2022 earnings per share to land around $115.50, implying a soft growth of around 3% compared to last year. This estimate is quite conservative, in my view, as operating profits grew 20% during Q1, and the unrealized losses that impact the bottom line during the quarter should only be a one-off effect.

Still, assuming this will be the case, Alphabet is currently trading at a forward P/E of about 20 at its current price levels. Note that this is almost the lowest multiple the stock has seen over the past five years.

Even in an environment of rising rates (cost of equities goes up), I find this multiple particularly attractive considering Alphabet’s growth metrics, unparalleled moat, and growing capital returns.

Wall Street’s Take

Turning to Wall Street, Alphabet has a Strong Buy consensus rating based on 32 Buys assigned in the past three months. At $3,335.94, the average Alphabet price target implies 43.8% upside potential.

Takeaway

Alphabet’s stock has experienced substantial losses over the past few months, along with many of its growth peers in the I.T. and communications sectors. In the meantime, however, the company has been delivering excellent results, and Q1 was no different.

Amid continuous growth across all segments, solid margin retention despite the ongoing rising-costs environment, and rising stock repurchases, I believe that Alphabet is currently the most attractively priced it has been for a long time.

While shares may continue to experience turbulence in the short term, they should reward investors sufficiently over the long term based on the underlying financials. Accordingly, I remain bullish on the stock.

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