After the 30% decline in early 2022 by the Big Tech Invesco NASDAQ 100 ETF (QQQ) equities, there are numerous potential buy candidates for long-term investors. I mentioned the logic of buying a collection of the strongest technology businesses in the world through a purchase of the QQQ product last week here. And, individual names like Meta Platforms/Facebook (FB) here and Netflix (NFLX) here today have their best risk/reward setups in many years, from a historical and mathematical perspective, following sharp panic selloffs.
Yet, one company remains the clear winner on a risk-adjusted basis in Big Tech. For a variety of reasons, I believe the smartest single Big Tech equity to own/buy in May 2022 is Alphabet/Google (NASDAQ:GOOG) (NASDAQ:GOOGL), and have expressed this view in articles since early 2020. The stickiness of its internet-delivered products with consumers and businesses is one reason. Another is a valuation near 10-year lows currently. Plenty of cash holdings and super-high profit margins are others. Lastly, in my view Alphabet’s collection of businesses is the best situated of the mega caps to survive a breakup mandated by the federal government, if that ever comes to pass. So, in combination I believe this stock has the best odds of continued outperformance of the S&P 500 index over the next 3-5 years, out of the universe of market capitalization choices over $100 billion in technology.
Operating Business Breakdown
Google controls a 90% share of global search engine use, making this service one of the most desired ways for businesses to target advertising to online consumers. Search and related services were responsible for 58% of company sales and a majority of operating profits in the first three months of 2022.
YouTube is the leading video upload service for consumers/businesses. It is by far the most profitable business model in streaming, where Alphabet pays next to nothing to create content, serving only as the hosting enterprise for millions of vlogs, entertainment shows, music videos, tutorials and more.
Google Cloud and Workspace hosting is running at a 9% market share worldwide, representing the third largest cloud network, behind Amazon (AMZN) and Microsoft (MSFT).
Other units include Pixel smartphone manufacturing and sales, Google Fiber high-speed internet access, Waymo research and development on self-driving cars, Google Pay and Wallet offerings for banking and transactions, plus leading Maps, Ads, Gmail, Android, Drive, Docs, Meet, Calendar and Chrome software for computer and smartphone use.
Revenues for the whole group of companies grew a terrific +24% in the March Q1 period just ended vs. a year ago, far above the CPI price level gain of +8% YoY. Honestly, if the economy grows and/or inflation rates stays high, Alphabet cannot help but expand sales by 10-15% annually just from demographic increases in internet usage worldwide.
Low Valuation Vs. High Growth Rate
The strongest argument in the buy proposition for Alphabet is its present valuation. Business results are available for investment at a lower valuation than most Big Tech names, while its growth rate is in the middle to high end vs. peers. To me, this dichotomy creates a bargain valuation, as long as growth continues at a well above-average pace.
Below is a graph of Wall Street analyst projected EPS gains between 2020 and 2024 for a list of Big Tech peers for size or direct competitors in one of its business lines, mostly in the software, streaming and internet selling spaces. I am including Meta, Netflix, NVIDIA (NVDA), Microsoft, Amazon, Apple (AAPL), Tesla (TSLA), Intuit (INTU), PayPal (PYPL), Adobe (ADBE), and Salesforce (CRM) for comparison.
To be honest, the NVIDIA growth rate is on a similar plane to Alphabet. However, Wall Street valuations differ dramatically. As an investor you want high growth, but you don’t want to pay an excessive price to get it. I mentioned NVIDIA as a sell idea several times in 2021, the last effort linked here, simply because of unsustainable overvaluation characteristics. My concerns have proven to be on target in 2022.
Enterprise value, taking into account total debt and cash on hand, appears to be a steal for Alphabet shareholders when reviewing “future” earnings projections. The basic EV to earnings before interest, taxes, depreciation and amortization is around 10.5x forward estimates. Only Facebook is lower, with weaker growth rates and extra issues/risk from possible government intervention in the operating business. EV to forward EBITDA for the peer group is closer to 18x for a median average, or 14x for the S&P 500 index looking into late-2022 and early 2023’s predicted fundamental results.
Lastly, price to trailing earnings, sales and cash flow, plus the EV to trailing EBITDA number, are all hovering near their cheapest levels since 2014. I dare you to find a similar growth story in a blue chip, valued as cheaply as Alphabet is right now.
Another positive for Alphabet/Google investors is the company has a super-strong, fortress-like balance sheet. At the end of March, the company held $134 billion in cash and short-term investments. That works out to almost $200 per share on the current $2100 share quote. This cash hoard stacks up quite favorably against $2.2 billion in current debt and lease obligations, or $12.85 billion in long-term debt, or $103 billion in total liabilities.
Absent the Facebook setup using zero debt, Alphabet has one of the lowest IOU designs of any Big Tech name. Free cash flow generation annually is today running at 5x its debt holdings. In other words, management could pay off all debt with ten weeks of free cash flow, not needed by business operations to keep results growing fast.
Again, when reviewing total liabilities vs. assets, Alphabet and Facebook are at the bottom of the barrel for risk. Both have excellent financial flexibility and can funnel cash reinvestment into any existing business or new avenue for growth management may choose.
Finally, net after-tax profit margins are an astonishing 27.5%, near the top of the pack for the peer group, and well north of the 10% margin normally considered strong by Wall Street for a typical blue-chip business.
During the wicked bear market dump in Big Tech since November, Alphabet/Google has been declining far less in percentage terms than peers. It never reached an extreme overvaluation, so it makes sense the stock quote would hold up better for investors. Below are graphs of the latest 6-month and 12-month total returns from the competitor group.
While I cannot point at a concrete technical reason for a reversal in the downside momentum of April-May, my favorite indicators are telling investors Alphabet is surviving the technology bust as well as it can. On the 2-year chart below, both the Negative Volume Index and On Balance Volume measurements are highlighting plenty of buying on weakness, with limited volume selling. The swift downdraft into May has also pushed the 21-day Average Directional Index closer to oversold/reversal territory. Looking for a decent bounce, if not an important bottom in price, is part of the intermediate ADX score above 25. We have reached the most stretched ADX trend score on selling intensity since March 2020 near the pandemic crash bottom (and before that instance, late 2019).
Outside of a stock market crash or depression in economic activity that decimates the advertising marketplace, the next largest risk to the business is Uncle Sam decides Alphabet should be split into two or three companies to promote competition. And, this risk is worth careful consideration with my personal odds of such a situation playing out in the 25% to 35% range over the next 3-5 years.
Nevertheless, if Big Tech comes under attack by state or federal government agencies, I remain confident owning 2-3 equities as separate pieces of the former Alphabet would not hurt long-term total returns much for shareholders. At this stage, YouTube doesn’t need a funnel of Google Search results pushing its videos. Search by itself is a great standalone product, especially if it keeps Gmail, Maps, etc. Spinning off Waymo and some of Alphabet’s add-on development ideas like Fiber and Pay/Wallet might slow their growth a bit, because the mother ship funds capital expenditures for these divisions. The Cloud unit might actually thrive as a separate company or be sold to/purchased by another technology firm like International Business Machines (IBM). Overall, I am modeling a major antitrust move would reduce long-term total returns for current owners from 15-20% annual growth rates to 12-15% for the combined units. All told, I think a government mandated breakup of Amazon, Apple or Microsoft would be more damaging for shareholders.
I have owned Alphabet on-again and off-again the last six months, and will likely purchase shares soon. The drawdown in April-May is tied to fears of a recession and a related slowdown in advertising spend by businesses. Honestly, the 30% drop in GOOG from its peak last year is already discounting a mild recession. If the Federal Reserve decides to raise rates gradually, or even backs off rate hikes by early summer, Alphabet could rebound 10%+ in a matter of weeks. In addition, if we can avoid a deep recession, the stock appears to be quite undervalued. A 20%+ rebound by the end of the year may become reality with new all-time highs above $3000 in 12-18 months. A total return advance of 40% (GOOG does not pay a dividend) for investors over a year is nothing to sneeze at, especially from a brand-name, blue-chip media and information giant.
What’s the downside risk on investment? A deep recession and new rounds of selling in Big Tech could drive GOOG closer to $1700 a share. Nevertheless, I believe the odds of a quote well under $2000 are actually quite low. We’ve just experienced a “normal” bear market drop of 20% to 30%, depending on which broad index you are tracking. Investors should now be laser-focused on upside potential in their market weightings. That’s what I am doing after being fully hedged for market direction risk in my regular brokerage account and 100% cash in my 401(k) at the beginning of 2022.
Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.