To The Moon

$Alphabet(GOOG)$

We've just come out of what has been the worst week for the S&P in 2025 so far, yet interestingly, Alphabet is one of the few companies up around 2%. However, when we broaden the view to include the entire year of 2025, we see a lot of red across the board, and Alphabet is no exception, down around 8% year-to-date.

That said, Alphabet still holds a double buy rating from both Seeking Alpha and Wall Street, and it's currently trading at the midpoint of its 52-week range, with an attractive forward P/E ratio, which we'll discuss shortly. The company has also massively outperformed over the last decade, up a staggering 5,129%.

So, should we consider adding Alphabet to our portfolio, or is it a trap that's only going to go lower? Let’s dive into our own valuation. First, institutions hold about 40% of Alphabet and have sold approximately $49 billion worth of shares over the last year. However, they bought nearly twice as much during the same period, and in the most recent quarter, their buying activity was even higher. This clearly shows that institutions are very bullish on Alphabet.

Next, let's highlight an undervaluation signal: Alphabet's current forward P/E ratio of 19.4 is below its 5-year average of 22.3. When comparing this to their 5-year average on the same basis, we see the “blue tunnel,” indicating the expected fair price, with Alphabet trading lower than even the bottom end of this range—suggesting a potential severe undervaluation.

Looking at Alphabet's valuation relative to its sector (communication services), it’s trading at a 48% premium. However, high-quality companies deserve to trade at a premium. Based on their 5-year average, Alphabet is currently about 24% below its historical valuation levels.

When we examine Alphabet’s revenue breakdown, we see that more than 50% comes from search advertising, typically in the 50-60% range. While many bearish articles claim Google’s search is dying—arguing it’s only used by older generations and being replaced by technologies like ChatGPT and others—this narrative doesn’t show up in Alphabet’s numbers. In their most recent quarter, search advertising was up 13% year-over-year.

What's especially noteworthy is that Google Cloud is Alphabet’s fastest-growing revenue stream, with a 30% growth rate compared to the same quarter last year. Google now processes over 5 trillion searches annually, more than double the number of queries it handled in 2016. Despite the doom-and-gloom narrative about Google search, the numbers tell a different story.

Looking at the latest search engine market share data (March 2025), Google commands around 90% of the market, with competitors like Bing, Yahoo, and Yandex far behind. Even though the market share fluctuates quarter to quarter, Google’s share remains consistently high, with the second-highest competitor at just 3.96%. All the talk about Google search being dead or only for old people seems more like external noise.

As for Google Cloud, it’s growing rapidly and currently holds 12% of the market share, ranking third behind Microsoft (21%) and AWS (30%). Just a few years ago, Google Cloud became profitable from an operating income perspective, and it’s now expanding rapidly, with double-digit year-over-year revenue growth—30% in the most recent quarter, up from 35% the quarter before. With consistent growth, it might not be long before Google Cloud overtakes Microsoft.

In summary, Alphabet continues to show strong growth, despite some of the bearish sentiment in the market.

We also see that around 10% of Alphabet's revenue comes from YouTube, and in the most recent quarter, YouTube's revenue increased by approximately 14% year-over-year. In fact, YouTube's advertising revenue has now surpassed Netflix's, as seen in the latest quarter. This growth in YouTube's ad revenue could help mitigate any future challenges Alphabet faces with its search business. We believe this is a long-term opportunity for Alphabet, especially as more people are tuning into YouTube, particularly in the U.S. where it currently accounts for about 11.1% of total TV time, ahead of Netflix at 8.5%. This shift is likely to continue as ad spending on YouTube increases.

As for Alphabet's earnings, their revenue came in slightly below expectations at $96.4 billion, while the market was expecting $96.6 billion. However, they beat expectations on earnings per share (EPS), with $21.15 versus the forecasted $21.13. Wall Street also closely monitors other granular details, and YouTube advertising revenue exceeded expectations, coming in at $10.47 billion, above the anticipated $10.23 billion. While Google Cloud showed strong growth, its revenue of $11.96 billion came in slightly below estimates.

Looking ahead, Alphabet anticipates growth in every one of the next four quarters, continuing its 100% track record of outperformance over the past year. With an expected EPS of around $9 for this year, the company has a forward valuation in the 19 to 20 range, as mentioned earlier.

One reason for the stock's challenges year-to-date is the company's announcement in February that it plans to invest about $7.5 billion in capital expenditures, a significant increase from the expected $5.9 billion. This surprised analysts and contributed to some backlash. Other companies in the Magnificent 7, like Amazon, also plan significant capital spending, with Amazon leading at $100 billion, calling it a "once-in-a-lifetime opportunity." For 2025, Alphabet’s expected capital expenditure is $7.5 billion, the third-highest among major tech companies, following Meta and Microsoft. In the previous year, Alphabet spent $53 billion, also the third-largest amount. These large investments are something investors need to keep an eye on, but it’s also important to understand the returns on invested capital. For Alphabet, the return has been increasing, reaching around 32% last year, which is a positive sign, especially considering the growing level of spending.

Alphabet’s growth grade for this episode is a B, with year-on-year revenue growth at 14%, and expected forward growth of 12%, well above the sector’s low single digits. Though this is slightly lower than their 5-year growth rate of 18%, it's still strong. They also anticipate a 17.7% growth in EPS over the next 3 to 5 years, significantly above the sector's 12% and just under their own historical growth rate of 17.9%.

Over the last 10 years, Alphabet has consistently achieved double-digit sales growth, excluding 2023. In 2024, revenue growth is expected to be 14%. Profitability is also strong, with an A+ grade for gross margin at 58%, well above the sector’s 53% and their own 5-year average of 56%. The bottom line is equally strong, with a 29% margin, far above the sector’s 4% and their own historical 24%.

Alphabet is one of the Magnificent 7, generating significant cash from operations—$125 billion, which is well above their 5-year average of $87 billion and far surpasses the sector’s $354 million. We also like to assess operational efficiency, and Alphabet has improved in this area over time, increasing from 26% in 2015 to 33% now. The company is also a consistent free cash flow generator, maintaining around 20% with a current 21% on a trailing 12-month basis.

Lastly, Alphabet boasts an outstanding balance sheet, with a net debt to EBITDA ratio of zero over the past 10 years. This means it could pay off all its debt, net of cash on hand, in less than a day—an exceptional financial position. While they’ve only recently started paying dividends, Alphabet’s financial health and stability are undeniable.

It seems to be in a relatively safe position at the moment. However, just yesterday, the Department of Justice reiterated its stance that Google should be broken up. We're still awaiting the final outcome, and we expect to hear a conclusion in the coming months.

Now, turning to our intrinsic value for Alphabet, it currently stands at $226, based on the DCF model. We've factored in a 20% average growth rate for free cash flow over the last 10 years, and we're projecting a 12% growth rate going forward. As always, these numbers are subjective, and you can access this model by clicking on the pinned comment below to run your own numbers for Alphabet or any other stocks you're considering.

With a 12% growth rate and an 8% discount rate, we calculate the present value of future free cash flows and terminal value. After adding the cash and subtracting total debt, we arrive at an equity value, which, divided by shares outstanding, gives us a fair value of $226. This indicates a 31% upside. For full transparency, at a 10% discount rate, we get $197, which translates to a 14% upside. At a 14% discount rate, the intrinsic value rises to $259, which represents a 50% upside.

We typically take the median growth rate of 12% as our base and apply a margin of safety (MOS). Starting with a 10% MOS, we would consider it a buy at $203. As we adjust the margin of safety, we move toward the current trading price, which today is around $170, offering a 25% margin of safety. Wall Street, for its part, has a target of $220 over the next year, translating to a 27% upside.

For those who believe a 12% growth rate is too optimistic, at a 10% discount rate, the intrinsic value is $197, and with a 10% margin of safety, a buy would be at $177. At a 15% margin of safety, it's not quite there. So, if you’re more conservative with your growth rate assumptions, a margin of safety in the 10-15% range could still make this a potential buy or portfolio consideration.

As always, we'd love to hear your thoughts—do you see this as a great opportunity to take advantage of, or do you think it’s a trap and should we expect further declines?

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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