Alphabet: Fundamentally Undervalued, But There Is Something More

seekingalpha2021-08-20

Summary Given the growth of EPS and free cash flow, Alphabet does not look expensive now. Looking at the forward multiples, especially in the context of expected EPS and revenue growth, the market is...

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Comments

1000010101O
2021-08-20
1000010101O
[Smile]
1000010101O
2021-08-20
1000010101O
Like
kino318
2021-08-20
kino318
Please like and comment
Zeruel
2021-08-20
Zeruel
Like pls
- kino318:
  done
GoG
2021-08-20
GoG
Buy
- GoG:
  buy
- Zeruel:
  ?
MrTig3r
2021-08-20
MrTig3r
2300 buy!
- mokkie:
  Nice

Leave a comment

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However, maintaining the current rate of growth of the company's market capitalization looks doubtful. Moreover, the main reasons for these doubts do not relate directly to Alphabet.\nData byYCharts\nIs Alphabet just growing or accelerating?\nAlphabet started publishing disaggregated revenue data relatively recently, but even that data is enough to see how rapidly growth in the key segments of the company's business has accelerated over the past three quarters:\n\n\nSource:VisualizedAnalytics.com\nIf we talk about revenue in general, then there is now an exponential growth. Moreover, the result of the last quarter turned out to be above the long-term trend:\nSource:VisualizedAnalytics.com\nOf course, this is a consequence of the increased interest in digital advertising during the phase of the end of the coronavirus pandemic. Basically, this was the expected effect.\nMarket Cap vs Financial Results\nThe most rough version of evaluating the current market price of a company is to analyze the mutual dynamics of changes in the size of capitalization and key operating indicators.\nOver the last decade, Alphabet's capitalization has been in a qualitative linear relationship with its revenue TTM absolute size. And this relationship indicates an overvalued state of the company even in the context of the expected results of the next three quarters:\nSource:VisualizedAnalytics.com\nBut in the case of EPS, Alphabet's current market cap is fairly balanced:\nSource:VisualizedAnalytics.com\nThe relationship between capitalization and free cash flow turns out to be of the highest quality. And this relationship also confirms the balanced state of the company's current price:\nSource:VisualizedAnalytics.com\nSo, at first glance, given the growth of EPS and free cash flow, the company does not look expensive now. And this is impressive.\nComparative Valuation\nComparative analysis of Alphabet's multiples did not give an unambiguous result. But it revealed one characteristic detail, which should be discussed.\nComparing Alphabet to a broad sample of tech companies through historical multiples, it can be concluded that the company is in balance with the market.\nThis is indicated by the EV/EBITDA multiple:\n\nSource:VisualizedAnalytics.com\nAnd the EV/FCF multiple:\n\nSource:VisualizedAnalytics.com\nBut if we turn to the forward multiples,they will not allow us to draw such a conclusion. So, judging by the Forward P/S (next FY) multiple, Alphabet is overvalued by 25%:\n\nSource:VisualizedAnalytics.com\nIf we adjust this multiple for the expected growth rate, the result will not change much:\n\nSource:VisualizedAnalytics.com\nJudging by the forward P/E (next FY) multiple, Alphabet is balanced:\n\nSource:VisualizedAnalytics.com\nBut, the growth-adjusted forward P/E multiple indicates overvaluation:\n\nSource:VisualizedAnalytics.com\nAs you can see, if we compare Alphabet in the context of the current multiples, then the company is quite adequately assessed. But if you look at the forward multiples, and especially in the context of the expected growth rates of EPS and revenue, then the market is pulling Alphabet down.\nFundamental Valuation (DCF model)\nTo forecast Alphabet's revenue for the next decade, I used the current averageestimatesof analysts. Importantly, sentiment about Alphabet's future growth has improved significantly this year:\nSource: Seeking Alpha Pro\nOperating margins have also jumped recently:\nData byYCharts\nBut the model is based on the assumption that the operating margin over the next 10 years will gradually decline from 26% to 21% in the terminal year. This is the standard approach, assuming increased competition in the industry.\nHere is the calculation of the Weighted Average Cost of Capital:\nSource: Author\nSome explanations:\n\nIn order to calculate the market rate of return, I used values of equityriskpremium (4.72%) and the current yield of UST10 as a risk-free rate (1.25%).\nI used the currentvalueof the three-year beta coefficient. For the terminal year, I used Beta equal to 1.\nTo calculate the Cost of Debt, I used the interest expense for 2019 and 2020 divided by the debt value for the same years.\n\nWhen building the model, I used the following key assumptions:\n\nThe relative size of CAPEX will be at the average of the previous six years (14%).\nThe averagetax ratewill amount to 26%.\n\nAnd, here's the model itself:\n(high resolution)Source: Author\nThe DCF-based target price of Alphabet's shares is $4,430, offering ~62% upside. But, if we moderate the forecast for the operating margin and suppose that UST10 rises to 2%, then the growth potential drops to approximately 30%. This, however, is also a positive result.\nTechnical picture\nMost stocks and indices follow their exponential trend, which tends to be well-identified on the graph with log y-axis. Let's take a look at Alphabet this way:\nSource:VisualizedAnalytics.com\nStarting from 2010, Alphabet's stock price had been following its long-term exponential trend. But now the company's stock price is above this trend by two standard deviations.It means that Alphabet's stock price is growing at a faster than exponential rate. Generally speaking, it indicates an unstable state.\nBut, sometimes this is a signal that the price intends to grow in this way and further. A prime example is Microsoft (MSFT), which overtook its long-term exponential trend last year:\nSource:VisualizedAnalytics.com\nDynamics of risks\nThe risks that will be discussed in this block do not relate to the company itself, but to the market as a whole.\nThe capitalization of Alphabet now accounts for about 4.3% of the capitalization of the entire US stock market. At the beginning of the year, this figure barely exceeded 3%:\nSource:VisualizedAnalytics.com\n\nOnly Apple (AAPL) and Microsoft have comparable shares...\nFurther, over the past 14 years, the value of the Nasdaq index as a percentage of the S&P 500 index has grown from 175% to 330%. Moreover, the dynamics of the last few quarters suggest that this trend has reached a certain ceiling:\nSource:VisualizedAnalytics.com\n\nAt the same time, microcycles allow us to expect that the market is entering a phase of increased volatility and tighter monetary policy:\nSource:VisualizedAnalytics.com\nAnd it was the ultra-soft monetary policy that allowed the US stock market to reach its current record level relative to GDP:\nSource: cmegroup.com\nIn short, the current state of the market in many aspects has reached extreme points and this is a cause for concern.\nBottom line\nLooking at the results that Alphabet has shown in the last two quarters, the company's current price is not surprising.\nBut the continuation of this growth at the same rates does not seem so obvious anymore. Especially with an eye to the general market situation and the expectation of a tightening of monetary policy in the US. On the whole, a neutral rating suggests 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