Alphabet Stock Is a Buy After Split

Alphabet GOOG/GOOGL dominates the online search market with 80%-plus global share for Google, via which it generates strong revenue growth and cash flow. We expect continuing growth in the company’s cash flow, as we remain confident that Google will maintain its leadership in search. We foresee YouTube contributing more to the company’s top and bottom lines, and we view investments of some of that cash in moonshots as attractive. Whether they will generate positive returns remains to be seen, but they do present significant upside.

Key Morningstar Metrics for Alphabet Stock

• Fair Value Estimate: $169
• Star Rating: 4 Stars
• Economic Moat Rating: Wide
• Moat Trend Rating: Stable

Economic Moat Rating

We assign Alphabet a wide Morningstar Economic Moat Rating, thanks to durable competitive advantages derived from the company’s intangible assets, as well as the network effect. We believe Alphabet holds significant intangible assets related to overall technological expertise in search algorithms and machine learning, as well as access to and accumulation of data that is deemed valuable to advertisers. We also believe that Google’s brand is a significant asset; “Google it” has become eponymous with searching, and regardless of actual technological competency, the company’s search engine is perceived as being the most advanced in the industry. In our opinion, Alphabet’s network effects are derived mainly through its Google products such as Search, Android, Maps, Gmail, and YouTube.

Read more about Alphabet’s moat rating.

Fair Value Estimate for Alphabet Stock

Our fair value estimate is $169 per share, equivalent to a 2022 enterprise value/EBITDA ratio of 20. We expect margin pressure in 2022 as the firm continues to increase head count (albeit slowing down in the second half) and invest aggressively in growth. We look for margin improvement in 2024-26. Our model represents a five-year compound annual growth rate of 14% for total revenue and a five-year average operating margin of 26%.

Read more about Alphabet’s fair value estimate.

Risk and Uncertainty

Our Morningstar Uncertainty Rating for Alphabet is High, primarily the result of high dependency on continuing online advertising growth. While we remain confident that Google will maintain its dominant position in the search market, a long-lasting downturn in online ad spending could have a negative impact on Alphabet’s revenue and cash flow, resulting in a lower fair value estimate. On the other hand, positive returns on Alphabet’s investments in cloud and moonshots could increase our fair value estimate considerably.

Read more about Alphabet’s risk and uncertainty.

Bulls Say

• As online users and usage increase, so will digital ad spending, and Google will remain one of the main beneficiaries.
• Android’s dominant global market share in smartphones leaves Google well positioned to continue generating top-line growth as search traffic shifts from desktop to mobile.
• The significant cash generated from Google’s search business allows Alphabet to remain focused on innovation and the long-term growth opportunities that new areas present.

Bears Say

• Alphabet has little revenue diversification, as it remains heavily dependent on Google and the state of the search ad space.
• Alphabet is allocating too much capital toward high-risk bets with a very low probability of generating returns.
• Google’s dominant position in online search is not maintainable, as more companies and regulatory agencies are contesting the methods through which the company has been extending its leadership.

Read more about Alphabet’s recent stock split.

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