Digital giant Alphabet (NASDAQ: GOOG) owns businesses from Google to YouTube. That sounds like a license to print money – and it is. Last year, for example, the firm earned well over a billion dollars a week on average. Despite that, Alphabet shares have been falling.
In fact, the shares have lost a quarter of their value over the past year. An underwhelming quarterly earnings report released yesterday could further hurt the shares. While revenues were 6% higher than in the same period last year, net income fell 26%.
Why I’d buy
Despite that, I see the current price of Alphabet shares as cheap.
The company has a business model that I think is world class. The costs of building a competitive platform would be very high. That alone acts as a barrier to entry for possible rivals. Alphabet’s businesses have a large installed user base. There would be a switching cost for them in terms of time and effort that might keep them loyal to Alphabet even if a rival offered an equivalent service.
Alphabet’s product ecosystem enables it to serve up ads without having to spend lots more money. Compare it to a traditional outdoor advertising firm. If such a business wanted to display more ads, it would need to own or rent more poster sites. Alphabet, by contrast, has a very small marginal cost when increasing the number of ads it displays online – meaning that it can make excellent profit margins.
Those characteristics add up to a profitable operation with a large opportunity in years to come and a massive captive market. I see that as a great business.
Alphabet shares look cheap
The key to successful investing, however, lies not only in buying into great businesses. I also need to build my stake at an attractive price.
The drop in Alphabet shares means that they now trade on a price-to-earnings ratio of just under 20. I see that as cheap for a business with the future earnings potential I believe Alphabet has. Admittedly earnings in coming years may be lower than before, if the company’s latest numbers mark the beginning of a trend. That is, increased competition from rivals such as TikTok and tightening advertising budgets at customers pose a risk to both revenues and profitability at Alphabet.
As a long-term investor though, I think the company’s scale and competitive advantage mean it will continue to be a profit machine in future. Taking advantage of the fall in Alphabet shares to add them to my portfolio could turn out to be a rewarding move when looked back on five or 10 years from now. That is why, if I had money available to invest today, I would make that move.
