Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) shares have produced a monster 6,510% return since their initial public offering in 2004. That gain certainly made early investors rich. But shares are taking a breather, as they're down about 13% from their peak from July this year.
If you're considering buying this top technology stock, which is worth more than $2 trillion at the time of this writing, continue reading to understand why that's a very smart decision for your portfolio.
Sustainable competitive advantages
I think the mark of a truly outstanding company is the presence of an economic moat. In other words, does the business in question possess durable competitive advantages that allow it to succeed financially for an extended period of time? Alphabet certainly fits the bill here. In fact, there are likely multiple competitive strengths at play.
For starters, Alphabet benefits from network effects. Its Google Search engine becomes more valuable to all stakeholders, including internet users, website publishers, and advertisers, the larger it gets. And YouTube, the leading streaming service, becomes better as the content offerings and viewership grows.
With 15 products and services that are each used by half a billion people or more, Alphabet is able to collect more data than nearly all businesses on Earth. In the internet age, this is an advantage. Alphabet can use this valuable info to glean insights that can inform corporate strategy and product development efforts.
In the past five years, Alphabet's return on invested capital (ROIC) has averaged 23.8%. This means that for every $100 reinvested into the business, the company is able to earn about $24 in profit. The fact that Alphabet's ROIC is more than double that of the average for the S&P 500 clearly demonstrates just how wonderful this business really is. Companies that don't possess economic moats typically have consistently low ROIC metrics.
Pristine financial condition
The market is full of growing and unprofitable businesses that aren't in the best financial shape. Investors who prioritize growth above all else might gravitate to these types of companies. But this adds risk to the equation. These unproven business models rely on favorable macroeconomic conditions in order to keep running.
Alphabet doesn't fall into this category. This company has been raking in profits for a very long time. For every $100 in revenue generated in Q2 (ended June 30), operating income was a stellar $32. Even during the digital ad market's weak period in 2022, Alphabet was still able to report an operating margin of 26%. The business has reached tremendous scale that allows it to leverage its expenses to the benefit of shareholders.
Alphabet produced $102 billion in operating cash flow last year. Management uses capital that's left after reinvesting into the business to fund ongoing share repurchases, as well as to help pay for the newly announced dividend. Risk is also drastically reduced because the company is sitting on a fortress balance sheet that has a current net cash position of $87 billion. This gives Alphabet the resources to invest in new areas, like artificial intelligence.
Alphabet's reasonable valuation
Alphabet has historically been a winning stock. And today, the company's market cap is north of $2 trillion. However, this doesn't mean that you're too late to the party. Even some of the most closely watched businesses are still worthy investment candidates.
As of this writing, Alphabet shares trade for a price-to-earnings (P/E) ratio of 23.8. This makes it the cheapest option among the popular "Magnificent Seven" grouping. Regulatory uncertainty might be the key factor weighing on the stock right now. But that doesn't take away from the fact that this is one of the highest-quality businesses out there. It deserves a spot in your portfolio.
Should you invest $1,000 in Alphabet right now?
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
