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Better Buy: Alphabet vs. Facebook

Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) and Facebook (NASDAQ: FB) are the top two companies in the digital ad space. One dominates internet search, while the other holds domain in the social media sphere. Due to their influence, both have claimed a place among the world's largest tech companies.

Moreover, both have invested heavily to prepare for the day when growth rates slow in the internet ad space. This could determine which tech stock enjoys more success in the long run. Let's examine both companies to determine which stock investors should choose going forward.

The state of Alphabet

The Google parent has suffered the worst crisis in its history as COVID-19 led to a modest year-over-year decline in advertising revenue (a first for the company). Nonetheless, dominance in search led to massive growth over its 22-year history, taking the market cap to just above $1 trillion.

3D representations of words like online advertising and digital marketing create an illustration

Image source: Getty Images

That value creation has left the company with more than $121 billion in liquidity. It has invested much of its resources in making itself a wellspring of innovation. Calico, a human health entity; DeepMind, which focuses on artificial intelligence (AI); and Waymo, which develops autonomous vehicle technology, are among its subsidiaries.

Nonetheless, more than 99% of Alphabet's revenue comes from the Google division. Moreover, revenue suffered a 2% decline in the most recent earnings report. This led to a 30% drop in net income. While most other companies suffered considerably more, such a performance is unusual for Alphabet.

In fairness, this situation is unlikely to last. Moreover, Alphabet holds ample cash reserves, and analysts expect earnings to rise by almost 28% in the next fiscal year. Plus, its forward P/E ratio of approximately 36 is well above Alphabet's average forward multiple of about 24 for the last five years.

Nonetheless, Alphabet's earnings report gives only scant mention to non-Google divisions. The company's many subsidiaries may point to numerous backup plans if Google falters. However, with little clarity as to what subsidiaries will drive revenue in the future, predicting what Alphabet will look like a few years from now remains difficult.

Where Facebook stands

Facebook fared somewhat better during the pandemic. In the quarter ended June 30, it still increased overall revenue by 11% as ad revenue rose by 10%. This helped Facebook's net income increase by 98%.

Facebook is a younger and somewhat smaller company. Nonetheless, its market cap of close to $750 billion still makes it one of the largest companies trading today. Moreover, the $58.2 billion in cash and marketable securities is only small when compared to Alphabet's liquidity.

Also, unlike Alphabet, which has ventured into multiple areas of tech, Facebook has largely stayed within the social media sphere. Its cash generation has allowed it to buy apps such as Instagram and WhatsApp. In many cases, it has enjoyed success copying smaller peers such as Snap or TikTok in adding features to Facebook.

Additionally, in a partnership with Shopify, it has added Facebook Shops. This will allow small and medium-sized businesses to post and sell their offerings on either Facebook or Instagram. In a research note, Deutsche Bank analyst Lloyd Walmsley said he believes this alliance could generate billions of dollars in revenue between ads and transactions.

Moreover, analysts predict earnings growth of more than 24% for this year and close to 27% in fiscal 2021. Also, with a forward P/E ratio of just under 34, its forward multiple resembles that of Alphabet. Though Facebook will likely not maintain this growth rate forever, it continues to increase earnings at a brisk pace.

Alphabet or Facebook?

Both companies should remain on a long-term growth trajectory. Moreover, the stocks' performances have closely resembled one another.

GOOGL Chart

GOOGL data by YCharts

However, knowing what we know now, I have to give the edge to Facebook. Facebook offers more consistent profit increases at approximately the same earnings multiple, and it has grown slightly faster than Alphabet stock in recent weeks.

More importantly, I think it has laid out a clearer path to growth. Though I expect Alphabet to prosper after growth in search slows, the unclear status of its subsidiaries points to an uncertain future. Until Alphabet lays out a clearer path, Facebook will offer its investors a more transparent investment case.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, and Shopify. 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.

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