The valuation of Alphabet Inc. (NASDAQ:GOOG) (NASDAQ: GOOGL) is out of step with the tech company’s strong and recession-proof market position.
Google’s business generates a huge amount of regular, predictable, low-risk cash flow that is expected to grow over the time.
Google’s strong free cash flow growth and good earnings performance over time make the stock a very attractive option for investing your money. Google’s low multiple of earnings to sales potential reduces risk, and the ability to increase cash flow in various market conditions makes GOOG one of the best stocks to invest in.
Gigantic free cash flow and shareholder-friendly management
Google’s management has demonstrated over time that they think long-term and spend money in a sensible, value-added way. Google has been at the forefront of many industries at the same time, whether it’s buying YouTube years ago, making smart, forward-thinking investments in the cloud market, or, more recently, of a relationship with Amazon to capitalize on the expansion of e-commerce.
Thanks to this foresight, the company’s revenue and free cash flow have steadily increased. Investors are particularly interested in Google’s free cash flow growth because free cash flow is a statistic that indicates the amount of cash a company could return to shareholders through dividends or stock buybacks.
When it comes to cash, Google is a real beast. In the last quarter alone, the company generated $25.1 billion in cash from operations. After deducting $9.8 billion in investments, the company had $15.3 billion. Google’s free cash flow growth has been nothing short of phenomenal, with total free cash flow increasing by 141.9% over the past five years.
What does Google do with all that money?
It buys back shares in the market with a large portion of its free cash flow. Alphabet’s board of directors has authorized the company to acquire $70 billion in shares, with transactions to be conducted as management deems appropriate. Google’s free cash flow and share buybacks have increased over time.
The free cash flow trend is positive and the company is about to experience a major trigger that could propel its free cash flow to new heights.
Growth catalyst: YouTube/Shopify partnership
YouTube made headlines just days ago when it announced a new partnership with e-commerce giant Shopify.
Shopify will integrate its shopping systems into creators’ YouTube pages, allowing viewers to shop directly on YouTube without leaving the site, as part of their collaboration.
Collaboration benefits from two major contributions: YouTube has 2 billion users connected per month and Shopify is the main platform for small businesses. There are considerable synergies in this relationship, as YouTube’s creative community will greatly benefit from in-app shopping services, while Shopify will benefit from entering a market that may not yet be well supplied.
In my opinion, small and medium businesses have a lot of overlap with the two main populations that use YouTube or the Shopify platform. YouTube will be able to benefit from Shopify’s expertise in inventory synchronization, while producers will be able to simply make their products available for purchase on their channel, resulting in a seamless shopping experience. The Shopify connection to YouTube also allows producers to sell stuff during live streams, which could be a game-changer not just for e-commerce, but for Google as well.
I’m very excited about this potential and think Google has a fantastic revenue opportunity here. Google monetizes YouTube largely through ads, but it also offers subscription services like YouTube Premium and YouTube TV. The eCommerce collaboration, which will be unveiled soon, could be a powerful accelerator for the exceptional sales development of the video streaming platform.
Google has a 5% return and the stock is a steal
Investing is simple. You buy high-quality companies with strong cash flows and attractive long-term growth potential in their respective industries. In an ideal world, this increase is heavily discounted, as it is for Google.
The market expects earnings per share of $5.47 in 2022, implying a return of 5.1% at the current price of $110. (multiple implied profit 19.8x). Google’s earnings yield is 6.0% based on expected earnings per share of $6.46 for next year. (implying a gain multiple of 16.8x).
An earnings yield of 5%, equivalent to a multiple of 20 times earnings, is rather low as the market consensus expects earnings growth of 18.1% year-over-year, indicating that the market worried too much about Google’s growth. However, the relationship between YouTube and Shopify may contribute to Google’s revenue growth in ways that current projections don’t fully reflect.
Beyond the P/E ratio, valuation indices have recently solidified, indicating that the market has become a bit more risk averse towards Google.
Valuation indices such as price to free cash flow ratio, enterprise value to EBITDA ratio and enterprise value to cash flow ratio have all dropped significantly in 2022, indicating that the market has started to undervaluing Google’s growth prospects.
Why Google might see a lower rating
Google’s cash flow is highly dependent on the company’s performance in the digital advertising industry. A recession has the potential to reduce Google’s ad revenue, which could translate into lower free cash flow.
Given the amount of Google’s free cash flow, the tech business is well positioned to weather a downturn. A drop in e-commerce spending that precedes the onset of a recession wouldn’t derail the YouTube/Shopify alliance, but it may take the market longer to recognize its true potential.
With a 16.8x earnings ratio, Google is a steal, and I’m aggressively buying the stock, GOOG, on the current decline in share price.
Google isn’t the only mega-cap tech company taking a beating right now, but the company’s cash flow is strong. Even though the stock may trade short-term due to economic news, the company’s long-term business focus is quite strong and free cash flow is growing nicely.
Management is shareholder-friendly and buys back a large number of shares, which helps shareholders. Google is a fantastic business that should not be passed up.