Sometimes it’s better to just keep it simple. As the great Warren Buffett famously said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Alphabet (GOOGL), parent of Google, YouTube, Android, and a growing cloud computing business, is very much a wonderful company at a fair price, notes Berna Barshay, editor of Consumer/Culture/Commerce by HedgeFundGirl.
Much has been made about the outperformance of the Magnificent Seven in 2023 – consisting of Alphabet, along with big tech peers Amazon (AMZN), Apple (AAPL), Meta Platforms (META), Microsoft (MSFT), Nvidia (NVDA), and Tesla (TSLA). The group was collectively up 75% in 2023 as of mid-December, driven by the nearly 250% move in Nvidia and 186% move in Meta.
Alphabet was up a relatively tame 54% in comparison, the “laggard” of the group (although that performance is obviously nothing to sneeze about). With this dramatic price appreciation in 2023, these seven stocks now comprise 30% of the market cap of the S&P 500.
Such outperformance and the resultant index domination has spawned a plethora of think pieces suggesting that the move in these stocks is done and that investors will look to rotate elsewhere in 2024. This may prove true for some members of the Magnificent Seven, but I think treating them like a monolith is a mistake.
Consider that the individual members of the Magnificent Seven sport vastly different valuations. While Tesla – arguably the constituent with the smallest competitive moat and most competition in the group – recently sported a P/E ratio over 80 and ecommerce and cloud giant Amazon sported a P/E just under 60, Alphabet traded at just under 24 times 2023 expected earnings.
Sure, that was a premium to the overall S&P 500 index, which traded at 21.5 P/E on this year’s earnings. But it was an extremely modest premium when you consider Alphabet’s superior growth outlook, margins, and financial strength versus the average for the S&P 500.
Alphabet is expected to grow its earnings 50% faster than the S&P 500 next year, and its extremely high operating margin is roughly double that of the S&P 500. Alphabet also has $120 billion of cash and equivalents sitting on its balance sheet – which give it outstanding financial stability and the flexibility to keep buying back stock, which helps propel EPS growth.
In fact, if you adjusted its stock price to back out its cash holdings, Alphabet trades in line with the S&P 500 despite having a much higher profit margin and an incredibly deep competitive moat, particularly in the core search business where Alphabet still sources the majority of its earnings.
Paraphrasing Buffett, with Google, you are getting an exceptional company at a decidedly average price. Don’t let the noise about the Magnificent Seven distract you from what should be a really easy investment decision.
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