Alphabet once again shows why it’s the best FAANG stock to own

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At the end of last week, we saw many FAANG stocks report their second quarter results. These are some of the most important companies in determining the direction of the vast market in the next three to five years.

While the faithful love Amazon and Apple thrilled investors with their earnings, I was mostly interested in how Alphabet (GOOGL 0.09%) (GOOG 0.08%) – Google’s parent company – is doing its advertising business amid a slowing economy. And boy, did the company deliver.

Here’s why its second quarter results once again show why Alphabet is the best FAANG stock to own right now.

Second quarter results: research is still king

Alphabet released its second quarter results on July 26 for the three months ending June. Revenue grew 16% year-over-year in constant currency to $69.7 billion. The majority of that growth comes from Google Search, which still accounts for the majority of Alphabet’s business, even in 2022. The segment generated $40.7 billion in revenue last quarter, up from $35.8 billion a year ago. a year (a jump of 13%).

Even as consumers around the world shift from buying durable goods during the pandemic to spending on travel and experiences, Google Search remains a big part of their lives — and therefore of advertisers’ lives.

Compare these results with the other digital advertising giant, Metaplatforms, parent of Facebook and Instagram. He saw revenue decline down 1% year-over-year in the second quarter due to a variety of factors, including Apple’s operating system privacy changes and increased competition from ByteDance’s TikTok.

Unlike other digital advertising companies, Google (especially search) faces minimal legitimate competition, making it less susceptible to disruption. While this may be a concern from an antitrust perspective, it leaves the company on solid footing, even as we head into a recession.

Cloud Losses and “Other Bets” Mask Profitability

Alphabet’s operating profit was $19.5 billion in the second quarter for an impressive operating margin of 28%. But that masks the true profitability of Alphabet’s core Google business. If we only look at Google services, the segment generated $22.8 billion in operating revenue out of $62.8 billion in revenue for an operating margin of 36%, well above what the consolidated figures from Alphabet.

So where are the losses coming from? That would be Google Cloud and its “other bets” segment. Google Cloud is a competitor to Amazon Web Services (AWS) and is growing rapidly. Revenue reached $6.3 billion in the second quarter, up 36% year-on-year, but the segment posted an operating loss of $858 million.

Given the profitability of AWS at scale, investors should expect Google Cloud to start generating positive operating revenue within the next three to five years.

Other bets are Alphabet’s division for lunar projects or highly speculative bets on emerging technologies. These include projects such as Waymo (self-driving cars) and DeepMind (artificial intelligence research). The segment only made $193 million in revenue last quarter and posted an operating loss of $1.69 billion, contributing most of the difference between Google Services’ operating profit and Alphabet’s consolidated earnings capacity.

The profit potential for these segments (especially other bets) is difficult to predict compared to Google search, but very few companies can finance billions in losses per year for new high-growth businesses while generating revenue. tons of cash for shareholders. This gives Alphabet an option and a scale advantage over almost every other company.

Valuation and share buybacks

Free cash flow from GOOG. Data by YCharts.

Perhaps the best part about Alphabet shares right now is that investors can buy shares of this dominant company at a reasonable price. With a current market capitalization of $1.5 trillion, it has an enterprise value of $1.36 trillion when you subtract its cash and marketable securities. Over the past 12 months, the company has generated $65 billion in free cash flow, giving the stock an enterprise value to free cash flow (EV/FCF) ratio of 21, just around of the market average. And that’s when the company invests heavily in Google Cloud and other bets, masking its true profitability.

In addition to this reasonable valuation, Alphabet poured its excess cash into share buybacks (as you can see with the falling number of shares in the chart above). This will drive growth in FCF per share, the real determinant of long-term shareholder return. Add this into the mix, and Alphabet is my favorite FAANG stock to buy right now.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a board member of The Motley Fool. Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple and Meta Platforms, Inc. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 appeals to Apple. The Motley Fool has a disclosure policy.

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