The headline of this article says it all: Alphabet (GOOG -2.71%) (GOOGL -2.65%) stock is cheaper than the S&P 500 (^GSPC -1.71%) index. It might seem a bit odd that a dominant tech company would fall behind the valuation of a broad market index, but that is exactly what happened.
This provides investors a rare opportunity to scoop up a best-in-class business for cheap and quells fears of potentially buying a significantly overvalued stock. I think it’s time to load up on shares (if you haven’t already), as Alphabet’s stock is primed to deliver market-beating returns.
Alphabet has multiple strong business units
Alphabet’s primary business is one of the most dominant in the world: Google. Many people surf the internet using the Google search engine, and Alphabet has built an incredible advertising business on top of that. In Q4, Google search generated more than $48 billion in revenue. Although its growth wasn’t super-fast by any means, it still rose 12.5% year over year, a strong pace for a mature business unit.
Alphabet gets its growth from other divisions, namely Google Cloud, its cloud computing segment that has seen strong growth thanks to the artificial intelligence (AI) arms race. Cloud computing is primed to benefit from the general build-out of AI because it provides computing muscle to its users that would otherwise be too expensive to buy.
Most companies can’t justify spending tens of millions of dollars on a powerful computing server dedicated to AI development. Instead, they can rent that computing power from a cloud computing provider like Google Cloud and use it whenever they need to. This allows them to scale usage up or down easily.
This is a profitable business for Alphabet because Google Cloud can charge a premium for using the computing power bandwidth versus buying the equipment outright. In Q4, Google Cloud’s revenue rose 30% to $12 billion, which is still about a quarter of the size of the Google search engine. Still, this is solid progress, and it’s an area that will continue to grow as the AI arms race continues.
With Alphabet’s revenue growing companywide 13% year over year, it’s clear that it has the ability to beat the market based on growth alone. However, it also improved its operating margin (rising five percentage points from 27% to 32% year over year) and repurchased $15.6 billion shares in the quarter, which caused its earnings per share (EPS) to rise by an impressive 31% year over year.
That doesn’t sound like a stock that should be valued at a discount to the market; it should have a premium. However, that’s not the case. But if you can find these deals in the market, buying them is a smart idea, as the market will eventually correct itself.
Alphabet’s stock is priced to buy now
Right now, Alphabet’s stock trades for 23 times trailing earnings and 20.6 times forward earnings estimates.
GOOGL PE Ratio data by YCharts
For comparison, the S&P 500 trades for 25.7 times trailing earnings and 22.5 times forward earnings estimates, so Alphabet’s stock is discounted to the market in both of these important metrics.
Alphabet’s optimism-producing growth is expected to continue, as Wall Street analysts project 11% revenue growth in 2025 and 2026, alongside EPS growth of 12% and 14%, respectively. Considering the stock market’s long-term average growth rate is 10% annually — some years it’s more; some years it’s less, even a big loss — and that stock returns are highly correlated to EPS growth over the long term, Alphabet looks like a stock that can grow faster than the market for some time.
As a result, it makes for a great purchase today for investors of all types, as it can be considered both a value play (cheaper than the market), as well as a growth story (Google Cloud and AI).
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Keithen Drury has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet. The Motley Fool has a disclosure policy.
