Going into earnings, is Alphabet stock a buy, a sell, or fairly valued?
With gen AI monetization and ad spending, here’s what we think of Alphabet stock.
Mentioned: Alphabet Inc (GOOGL)
Alphabet GOOGL is set to release its third-quarter earnings report on Oct. 29. Here’s Morningstar’s take on what to look for in Alphabet’s earnings and stock.
Key Morningstar metrics for Alphabet
- Fair Value Estimate: $209.00
- Morningstar Rating: 4 stars
- Economic Moat: Wide
- Morningstar Uncertainty Rating: Medium
Earnings release date
Tuesday, Oct. 29, before the start of trading
What to watch for in Alphabet’s Q3 earnings
- We will be keeping a keen eye on generative AI monetization (via AI overviews, Gemini adoption, and increased Google Cloud Platform spending), which we think will be investors’ main concern for this report.
- Investors were disappointed by YouTube’s growth last quarter. YouTube ad/sub spending will also be worth keeping an eye on.
- Any commentary on advertising spending, particularly relating to new AI overviews, will be noteworthy, along with Alphabet’s thoughts on the general ad climate.
- We view Alphabet’s current price dislocation as resulting from concerns about AI impacting search and antitrust. While antitrust is out of management’s hands (and they won’t comment on active cases on an earnings call), the firm could provide more clarity on how they’re planning to monetize AI. Part of this monetization story also depends on ROI, and Alphabet’s capex is up markedly (with an even higher number slated for next year). We think investors would like clarity on ROI, and how much fungibility is baked into these numbers. If demand dissipates for gen AI, can Alphabet roll back capex, reallocate AI data centers for other uses, and so on?
Fair Value Estimate for Alphabet
With its 4-star rating, we believe Alphabet’s stock is undervalued compared with our long-term fair value estimate of $209 per share, implying a 2024 adjusted price/earnings multiple of 27 times and an enterprise value/adjusted EBITDA multiple of 17 times. We forecast Alphabet’s top line growing at a 10% compound annual growth rate over the next five years.
Economic Moat Rating
We believe Alphabet has a wide moat, owing to the intangible assets, network effect, cost advantage, and customer switching costs that permeate its businesses. While Alphabet reports its operating segments as Google Services, Google Cloud, and Other Bets, we believe a different split is more appropriate to analyze its moat and competitive advantage. We look at Google Search, YouTube, Google Cloud, Android and Google Play, Devices, and Other Bets (which include Google’s aspirational projects, such as self-driving vehicles and internet access).
Financial strength
We view Alphabet’s financial position as virtually unassailable. The firm closed out 2023 with cash and cash equivalents of $111 billion, more than offsetting its debt balance of $13 billion. The firm’s advertising business is a cash-generating machine, churning out tens of billions of dollars in free cash flow annually. Alongside advertising, Alphabet is making progress on diversifying its cash generation, with Google Cloud Platform and YouTube subscription sales as additional free cash flow drivers.
Risk and uncertainty
We assign Alphabet an Uncertainty Rating of Medium, reflecting our belief that despite the near-term uncertainty around antitrust regulation and potential competition in the AI-infused search market, the firm is well-positioned to expand its overall business while maintaining a rock-solid balance sheet. Looking ahead, we believe Google’s intangible assets and network effects will likely safeguard its dominance in the search space. Further, the firm’s continued investments in AI, which it can leverage across nearly every business it operates, should be value accretive. At the same time, we think Google Search’s status as the runaway leader in search could come under pressure, primarily due to antitrust scrutiny. While we don’t see the firm’s market leadership slipping due to antitrust concerns, this issue adds uncertainty to an otherwise stable business.
GOOGL bulls say
- Alphabet’s core advertising business is deeply entrenched in advertising budgets, letting the firm benefit from a secular increase in digital advertising spending
- The firm’s advertising business generates substantial cash flows it can reinvest in growth areas such as Google Cloud Platform, AI-infused search, and aspirational projects such as Waymo.
- Alphabet has a huge opportunity in the lucrative public cloud space since it’s a key cloud vendor for enterprises looking to digitize their workloads.
GOOGL bears say
- While Alphabet seeks to diversify its business from search, text-based advertising remains the largest contributor to its top line, creating a concentration risk.
- Alphabet’s continued investments in new, often unproven technologies via its Other Bets business have dragged on cash flows.
- Regulators worldwide are keying in on Alphabet’s search dominance and could upend the market through deep structural changes.
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Terms used in this article
Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.
Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.
Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.
Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.