After Earnings, Is Alphabet Stock a Buy, a Sell, or Fairly Valued?

Why it matters: We saw Alphabet’s fourth-quarter earnings as further evidence of its sound artificial intelligence strategy, with the firm leveraging AI in its core advertising business as well as capitalizing on AI spending via Google Cloud.

• While advertising demand was seasonally strong, with ad sales up 11% year over year, we were particularly impressed by the firm’s commentary on AI Overview monetization, which is approximately at par with traditional search monetization despite its launch just a few months ago.

• Google Cloud’s revenue growth decelerated to 30% annual growth from 35% in the previous quarter. We attribute this deceleration primarily to Google Cloud being capacity-constrained (similar to Microsoft Azure). Once new capacity comes online in 2025, we forecast growth to inflect upward.

The bottom line: We raise our fair value estimate for Alphabet to $237 per share from $220 as we bake in the firm’s strong fourth-quarter top line, which was well ahead of our prior estimate, as well as a reacceleration of Google Cloud sales as more capacity comes online in 2025.

• Shares traded down after hours as investors were likely left unimpressed by the cloud deceleration. We see this selloff as a buying opportunity and continue to view Alphabet’s full-stack approach to AI—which includes infrastructure, software, applications, and ads—as a solid long-term strategy.

• On the margin front, we believe Alphabet’s operating margins will likely stay flat at 32% over the next five years as depreciation charges from investments in AI offset any efficiency gains or headcount/real estate optimizations that the firm is planning.

Alphabet Stock Price

Source: Morningstar Direct.

Fair Value Estimate for Alphabet

With its 4-star rating, we believe Alphabet’s stock is undervalued compared to our long-term fair value estimate of $237 per share, implying a 2025 adjusted price/earnings multiple of 26 times and an enterprise value/adjusted EBITDA multiple of 19 times. We forecast Alphabet’s top line growing at a 10% compound annual growth rate over the next five years.

Drilling deeper into the firm’s various segments, we expect Google Search to grow at a mid-to-high-single-digit level over the next five years as the digital advertising market matures and growth rates taper off after a robust few years following the pandemic. We expect YouTube to grow at a low-double-digit rate over the next five years, with a strong advertising business being increasingly supported by a growing subscription business.

Read more about Alphabet’s fair value estimate.

Alphabet Stock vs. Morningstar Fair Value Estimate

Source: Morningstar Direct.

Economic Moat Rating

We believe Alphabet has a wide moat, owing to the intangible assets, network effect, cost advantage, and customer switching costs that permeate its businesses. While Alphabet reports its operating segments as Google Services, Google Cloud, and Other Bets, we believe a different split is more appropriate to analyze its moat and competitive advantage. We look at Google Search, YouTube, Google Cloud, Android and Google Play, Devices, and Other Bets (which include Google’s aspirational projects, such as self-driving vehicles and internet access).

Read more about Alphabet’s economic moat.

Financial Strength

We view Alphabet’s financial position as virtually unassailable. The firm closed out 2024 with cash and cash equivalents of $96 billion, more than offsetting its debt balance of $11 billion. The firm’s advertising business is a cash-generating machine, churning out tens of billions of dollars in free cash flow annually. Alongside advertising, Alphabet is making progress toward diversifying its cash generation, with Google Cloud and YouTube subscription sales as additional free cash flow drivers.

Read more about Alphabet’s financial strength.

Risk and Uncertainty

We assign Alphabet an Uncertainty Rating of Medium, reflecting our belief that despite the near-term uncertainty around antitrust regulation and potential competition in the AI-infused search market, the firm is well-positioned to expand its overall business while maintaining a rock-solid balance sheet. Looking ahead, we believe Google’s intangible assets and network effects will likely safeguard its dominance in the search space. Further, the firm’s continued investments in AI, which it can leverage across nearly every business it operates, should be value accretive. At the same time, we think Google Search’s status as the runaway leader in search could come under pressure, primarily due to antitrust scrutiny. While we don’t see the firm’s market leadership slipping due to antitrust concerns, this issue adds uncertainty to an otherwise stable business.

Read more about Alphabet’s risk and uncertainty.

GOOGL/GOOG Bulls Say

• Alphabet’s core advertising business is deeply entrenched in advertising budgets, letting the firm benefit from a secular increase in digital advertising spending

• The firm’s advertising business generates substantial cash flows it can reinvest in growth areas such as Google Cloud Platform, AI-infused search, and aspirational projects such as Waymo.

• Alphabet has a huge opportunity in the lucrative public cloud space since it’s a key cloud vendor for enterprises looking to digitize their workloads.

GOOGL/GOOG Bears Say

• While Alphabet seeks to diversify its business from search, text-based advertising remains the largest contributor to its top line, creating a concentration risk.

• Alphabet’s continued investments in new, often unproven technologies via its Other Bets business have dragged on cash flows.

• Regulators worldwide are keying in on Alphabet’s search dominance and could upend the market through deep structural changes.

This article was compiled by Gautami Thombare.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.