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Alphabet Inc (GOOGL) Takes Too Much Heat for Moonshots and the Cloud

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Google parent Alphabet Inc ( GOOG , GOOGL ) is paring back on moonshot spending and making some important headway in growing its cloud business, but the market remains unimpressed with GOOGL stock. Is it still a buy?

Alphabet Inc (GOOGL) Takes Too Much Heat for Moonshots and the Cloud

GOOGL stock changes hands at 18.7 times earnings on a forward basis. That doesn't sound so cheap on the face of it, but by relative valuation metrics it's not quite square with Alphabet's growth prospects.

Shares in Alphabet are lagging the market for the year-to-date with a loss of 3%. The S&P 500 is close to flat. What's more interesting is GOOGL stock's valuation. If a stock's price-to-earnings multiple can be seen as a sort of proxy for sentiment, then feelings toward Alphabet are lukewarm at best.

For example, the S&P 500 fetches a forward P/E of 16.5 , according to Yardeni Research. Sure, that's about 12% cheaper than GOOGL, but the benchmark index has a much more sluggish growth forecast. Whereas GOOGL is projected to put up long-term growth of 16.5% per annum, the S&P 500 is expected to deliver less than 10% per annum.

Expressed as a ratio, the broader market has a price-earnings-to-growth of 1.7; GOOGL stock sits at 1.3. In other words, the broader market is significantly more expensive than GOOGL stock, even though the tech giant promises greater earnings growth.

So What Gives With GOOGL Stock?

A number of headwinds weigh on GOOGL stock's multiple, from its sheer size to falling ad prices to lackluster economic growth in the U.S. and abroad.

But a couple of issues investors really don't like are Alphabet's profligate spending on ambitious projects with no regard to profitability, and its also-ran status in the competition for providing cloud-based services.

Happily for shareholders, GOOGL is addressing both problems up front.

Alphabet's chief financial officer pledged to spend less on what it calls other bets, such as Google Fiber and self-driving cars. This is something the market has wanted for a while. According to Jackdaw Research via Business Insider , "the Other Bets group posted an operating loss of $3.57 billion on $448 million in revenue in 2015."

However, the reality is that Alphabet doesn't really plow that much capital spending into moonshots. A bigger drag on GOOGL stock is that it's in danger of missing out on its share of the cloud. Cloud spending came to $175 billion last year and should rise to $315 billion by 2019, according to Gartner , a market research firm.

And yet the company's market share is kind of laughable.

Amazon.com, Inc. ( AMZN ) and Microsoft Corporation ( MSFT ) are the undisputed leaders, with market shares of 31% and 9%, respectively. As for Alphabet, it places fourth - behind International Business Machines Corp. ( IBM ) - with 4% of the market for spending on cloud services.

The good news is that Alphabet is taking the cloud segment very seriously. It has recently picked up customers such as Apple Inc. ( AAPL ), Walt Disney Co ( DIS ) and Home Depot Inc ( HD ). Revenue from the business more than doubled last year (over a relatively small base).

Bottom Line

Alphabet's Google Cloud Platform may have a lot of catching up to do, but the race is hardly finished.

Discounting GOOGL stock for lame cloud performance and moonshot spending is fine, but let's not go nuts. The cloud promises a huge opportunity for top-line growth. Unprofitable spending - not that big of a deal to begin with - is coming under scrutiny.

There's no changing the market's mind with arguments, but even cautious optimism suggests that Alphabet stock is a bargain these days.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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