Is Alphabet (GOOG) a buy at $132?
Please ignore number rounding
Let’s take a look using The Investing Course’s valuation framework.
In 2022 Alphabet’s revenues were $283B, up 10% from the year before. In 2023 it’s on track for $305B (+8%). Gross profits grew by 7% in 2022 to $157B. The last 4 quarters gross profits amounted to $167B. That last number can be seen as the actual size of profits as of today.
How much is this economic situation worth? Well, you can see a stock purchase as you making a loan to the market. It’s worth it (or more) if you have a good chance of getting your money back with a decent or high interest.
GOOG share price
4 years ago the price was half today’s level. Where will it likely be 4 years into the future?
Is back to pre-covid/recent lows of $75-100 or challenging the recent peak (all time high) of $150 more likely? How would you know?
One quick way of checking your chances for a decent return is by making a reasonable forecast for sales and profits, as well as for the likely future valuation multiples.
Don’t know any economics? You can still extrapolate some simple trends just using history as a guide. Growth and profitability are likely to align in some way or another to historical trends, unless something truly unexpected happens.
Making forecasts, without knowing the industry, company or accounting and economics
Alphabet’s sales have grown by about 15-20% per year the last decade, with 2022 and 2023 as strong/weak outliers. After a weak 2023, next year could have been expected to be better than average instead, to keep the average constant. On the other hand, a global recession is looming due to high and rising interest rates working their way through the economy.
GOOG Annual Revenues
GOOG Quarterly Revenues
I would thus guess growth will be lower than GOOG’s average, as inflation cools down, unemployment increases, and a lot more of clients’ money is spent on mortgages and energy. I think Alphabet should be happy to grow by 10% per year the coming 4 years 2024-2027.
Sales for 2027 thus could be estimated at around $305B*1.1*1.1*1.1*1.1 = $445B
The gross profit margin has held quite steady around 55% the last few years. It used to be higher but competition is heating up, not least after the latest AI boom boosting competitors.
GOOG gross profit margin
The gross profit for 2027 should be around $445B x 55% = $245B
Right now, the last four quarters of gross profits were $167B and GOOG has a market value of $1.69T ($1690B). That means GOOG’s market valuation multiple relative to gross profits is 1690/167 = 10x.
Assuming the market in four years will still award GOOG a 9-10x Gross Profit multiple, GOOG’s market cap. will be in the range of [9 to 10] x $245B = $2.2T to $2.5T.
In order to calculate the likely future share price we also need to know how many shares are still outstanding for GOOG. Often, the number of shares is fairly constant, but not for GOOG.
GOOG # shares outstanding
The last available # of shares (Q3 2023) was 12.8 billion shares, about a billion lower than four years ago. In four years time it might have shrunk by another billion shares to around 12 billion shares, but probably not much lower due to lower profit and cash flow growth (less available cash for buybacks and adding to the net cash position at the same time).
The market cap per share about four years from now should be closer to $2.5T/12B = $208 per share. It’s quite a bit higher (208/132-1 = +58%) than today’s share price of $132. But is it worth the gamble that our estimates are correct?
Let’s compare GOOG to an obvious alternative: on average over long periods of time (decades and centuries) the stock market has yielded a total annual return of 10%.
GOOG’s estimated 12% per year is a bit better than that, but there is a catch. GOOG is just a single individual company and a lot can happen to a company that just wouldn’t happen to the average of all the 500 stocks in the S&P 500 index. An investor can on average as an alternative simply buy the index and keep making 10% per year with zero effort.
12% per year would still be better, but we would have exposed ourselves to the risk of among other things poor management decisions, FTC measures, a lower growth rate than estimated as the company becomes larger and the economy grows weaker, profit margins fall due to increased competition, and not least to lower valuation multiples if growth slows.
THE RISK OF LOWER VALUATION
On average the S&P 500 index has historically been valued at around 15x earnings. GOOG’s P/E multiple is 25.3, i.e., considerably higher than the historical market average, the average that has as stated above tended to produce 10% annual returns.
GOOG’s P/E ratio (on last twelve months profits)
GOOG has typically been valued at 25x or more, but the future might very well look a little different to the past, due to higher interest rates and lower growth than in GOOG’s past.
GOOG’s profit multiple could fall by over 30%, if it were to close the gap toward the market as GOOG becomes more and more average, or is seen as such. A 30% lower future share price than our first estimate of $208 would be just $208*0.7 = $145, only 10% above the current price. Four full years from now!
An alternative calculation focuses on Sales and the Price/Sales multiple instead of earnings and P/E. At the pessimistic $145 share price in 2027, the Price/Sales multiple would be 3.9x rather than today’s 5.5x. That’s still a lot higher than the market’s historical average of just about 1.0x. On the other hand, GOOG’s high margins, asset-light operations and demonstrated ability to grow faster than the economy warrants a multiple of several times the average. Whether 4x, 5x or 6x is warranted is taught in The Investing Course. It’s not very complicated but takes more than just a short blog post or newsletter to explain.
If P/S were to fall to 3.9x, then buying GOOG shares today is not attractive at all
You’ll learn the underlying techniques for making forecasts and estimating future stock prices in The Investing Course.
That includes estimating the relative risk level for various investments.
For example if the stock market’s risk level is defined as 100, then a typical stock, more or less reflecting the average stock on the market, could also be assigned a risk score of 100. However, due to idiosyncratic risks for individual companies, at least 125 would be advisable as a benchmark for GOOG. On the other hand, GOOG’s strong position in the economy, and other positive characteristics, probably warrant a better base score than the market. Hence, a final risk score of the market’s 100 might still be the most relevant one. The risk score should reflect how attractive it is to assume individual share price risk for the company in question vs. a broad equity portfolio.
Assigning risk scores is more important and useful for comparing single stocks than vs. the market. Suffice to say however, that considering that the market promises 10% per annum on average over a full cycle, a single stock should always have prospective returns of at least 15% per year, to be worth the risk assumed by investing in individual stocks. Another way to express that would be through a base level risk score of 150 for the average stock. I’ve used 150 in the GOOG example today, but don’t take it at face value as the correct risk assessment for Alphabet relative to the market.
If recent growth and profitability trends are reliable, and valuation multiples hold more or less steady, then GOOG’s share price should rise by 60% over the coming 4 years, or 12% per year. That, however, is not really worth the risk of being wrong in one way or another, or simply having bad luck. Unless you really have insight into GOOG’s plans and prospects, it’s a better risk/reward/effort combination buying a broad mutual fund or a corporate bond, than betting on GOOG.
Check out The Investing Course, to learn more about how to find, value and invest in stocks, how to manage timing and risk, as well as take stock price trends and the overall macro picture into account in your investing.