Google’s parent company Alphabet (NASDAQ: GOOG) released its 2018 results amid the flurry of news over the past few weeks. Overall the figures looked good to me, even though the market’s reaction was more ambivalent. I’ll start with the major plus point: growth is strong, and I think you can make a good case that it is trading at a reasonable price (GARP). Fourth quarter 2018 revenue increased 22% on Q4 2017 (23% in constant currency terms) and earnings per share clocked in at $12.77, some 17% higher than Wall Street predictions.
As for the market’s mixed response, it seems that mostly came down to the cash flow situation. Right now Alphabet is spending a heck of a lot on capital expenditures. Of the almost $13 billion it generated in the last three months of 2018, 55% ($7 billion) went on purchases of property and equipment. The comparable ratio in Q4 of 2017 was around 42%, and it’s that trend that has got some folks spooked. The firm’s operating margin dropping to 21% from 24% (Q4 2017) didn’t help either.
As far as I can see that is pretty much the extent of the bad news. Good news is still plentiful though in my view. Firstly the growth situation which I mentioned already. Five years ago Alphabet/Google earned around $18 per share in net profit. Last year (FY 2018) the company reported net profit of $43.70 per share. Analysts expect that to hit over $55 per share by the end of next year (FY2020). By FY 2022 those analysts expect earnings per share to reach nearly $75 per share. In other words the double-digit per annum juggernaut is expected to chug along nicely.
Secondly, the valuation seems very reasonable. At Friday’s close you could pick up Alphabet shares for around $1,115 each. That points to a valuation of 25x prior year earnings per share. Not too unreasonable for a strong growth company, but given it doesn’t pay a dividend or engage in meaningful share repurchases you might thing it a tad underwhelming.
This leads us to the third point: Alphabet’s fortress balance sheet. At the end of 2018 the company had roughly $16.5 billion in cash & cash equivalents, $92.5 billion in short-term investments and a further $14 billion in longer dated investments. On the other side was just $4 billion worth of total debt.
It kind of goes without saying but that is an absolutely gargantuan position. On a per-share basis it means that Alphabet has around $160 of its share price in the form of cash and income bearing investments. There are two upshots to this. Firstly Alphabet’s industry is obviously somewhat volatile in terms of both of regulation/legislation and business disruption. Having a $120 billion war chest ready to face those sorts of challenges is a good thing in itself.
Secondly, it makes the valuation look quite a bit more expensive than it really is. Take the net cash balance away from the stock price leaves a “debt adjusted” P/E ratio under 20x last year’s earnings; rather more attractive than the 25x I quoted earlier. For a company with a realistic shot of posting double digit average annual earnings growth over the next several years it represents a solid GARP candidate.