Better advertising stock: Alphabet vs. Amazon

Both stocks will probably beat the market, but one is likely to serve ad-oriented investors better.

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Advertising on the internet has become a lucrative business that has boosted some of the biggest tech companies. Google parent Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) used ads to monetize its sites, and this strategy has become enormously successful. 

Now, after seeing the success of Alphabet and Facebook parent Meta Platforms in the ad space, Amazon (NASDAQ: AMZN) has begun to monetize its extensive web presence by selling ads. The question for investors is whether such a move makes Amazon a better ad stock than Alphabet. 

The case for Alphabet

Alphabet is one of the leading pioneers of internet advertising. The company became the dominant search engine soon after its founding in 1998. Beginning in 2000, it attached ads to its searches, and its business was born. After buying YouTube, that site evolved into another primary platform for advertising.

So profitable was this business that it has since invested in dozens of other business ventures and holds almost $140 billion in liquidity at the end of the first quarter of 2022. This gives it one of the most solid balance sheets in corporate America.

Today, it has gradually diversified its revenue base away from advertising, increasingly emphasizing its Google Cloud offering. Nonetheless, advertising made up $55 billion of its $68 billion total revenue in Q1, or about 80%. That total revenue surged 23% compared with the same quarter last year.

Admittedly, its Q1 net income fell 8% year over year amid losses in equity investments. Still, the company earned more than $16 billion during that quarter, which helped to add more than $15 billion to its quarterly free cash flow.

Alphabet is not immune from the Nasdaq bear market as the stock price has fallen 6% over the last 12 months. However, its P/E ratio of 22 is near a multi-year low, an indication that this lucrative advertising play has become a bargain. 

Where Amazon currently stands

Although most consumers regard Amazon as one of the top e-commerce companies, it pioneered the cloud through Amazon Web Services (AWS). AWS remains the leading cloud company by market share according to Synergy Research Group, and the AWS segment has usually accounted for the majority of the company's net income.

Also, while Alphabet is the ad company increasingly moving into the cloud, Amazon is the cloud leader looking to fulfill its potential as an internet advertiser. The company initially launched Amazon Advertising years ago to better monetize its sprawling web presence.

Amazon had not emphasized this segment in its earnings reports and did not publish any advertising revenue figures until the fourth quarter of 2021. Nonetheless, in Q1 it reported ad revenue of almost $7.9 billion, a 23% increase compared with the year-ago quarter. In total, advertising accounted for about 7% of the company's $116 billion net sales for the quarter.

Still, Amazon has struggled with profitability as inflation hit its e-commerce segment. The company lost $3.8 billion in Q1, a sharp reversal from its $8.1 billion of net income in the first quarter of 2021. 

Additionally, Amazon's stock price has fallen by more than 35% year over year. And while its P/E ratio of 56 is just above multi-year lows, its earnings multiple far exceeds that of Alphabet. Although these conditions are not necessarily a reason to turn negative on Amazon, it has remained a comparatively pricey stock.

Alphabet or Amazon -- which to choose?

Despite efforts to diversify away from advertising, Alphabet looks like a better choice for advertising investors. Admittedly, both stocks lead critical parts of the tech sector and should beat the market long term.

However, Alphabet has kept its net income positive in this environment. Moreover, ads are still the primary driver of the company's considerable cash flows. After adding the Google parent's much lower valuation to the list of considerations, many prospective Alphabet investors may decide to buy now and hold forever. 

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Will Healy has no position in any of the stocks mentioned. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool Australia has recommended Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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