This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) reported excellent first-quarter 2025 earnings. It also raised its dividend by 5%, marking the first raise since Alphabet initiated its dividend last year.
And yet, Alphabet is still down big year to date -- underperforming the Nasdaq Composite (NASDAQINDEX: ^IXIC) and many of its megacap growth stock peers.
Here's why Alphabet's latest results reinforce its underlying investment thesis and why Alphabet is a top growth stock to buy now.
Alphabet's blowout quarter
There was a lot to like from Alphabet's latest print.
Revenue jumped 12% while operating income grew by 20% and diluted earnings per share (EPS) skyrocketed 49%.
High-margin segments like Google Search and YouTube have led to steadily rising revenue and a 10-year-high operating margin.
GOOGL Revenue (TTM) data by YCharts
Alphabet breaks up its business into two segments: services and Google Cloud.
Services include Google Search, YouTube, Google Network, and subscriptions, platforms, and devices.
Services brought in $77.26 billion in revenue in the recent quarter, $50.7 billion of which was Google Search. The segment's operating income was a whopping $32.68 billion -- good for a 42.3% operating margin.
Meanwhile, Google Cloud brought in $12.26 billion in revenue -- a 28% year-over-year increase. But it only booked $2.18 billion in operating income for an operating margin of 17.8%. Granted, margins could be a lot higher if Alphabet weren't in expansion mode. But margins are low because Alphabet is pouring resources to try to take market share from rivals like Amazon Web Services and Microsoft Azure.
Risks worth considering
Alphabet's results were excellent, so investors may be wondering why the stock price remains beaten down. Arguably, the two primary reasons are Alphabet's increased spending and uncertainty regarding the sustainability of Google Search.
Alphabet's capital expenditures (capex) in the recent quarter were $17.2 billion -- a staggering 43% increase compared to the first quarter of 2024. For the time being, Alphabet can absorb higher capex since it is growing revenue and operating margins at such a strong pace. But it needs to keep up the pace to justify higher spending.
The elephant in the room is Google Search. As mentioned, Google Search ad revenue topped $50 billion in the recent quarter, or 56.2% of total revenue. But Google Search is under pressure from rival information resources like ChatGPT or even TikTok and Meta Platforms' Instagram, which younger generations are increasingly using to search for information and content. Last week, Meta Platforms released a stand-alone AI app powered by Llama 4 -- its latest large language model.
In sum, it's unclear if Alphabet's high capex will pay off or if Google Search will stay as dominant as it has been for decades. Or put another way, it seems Alphabet is on the defensive, whereas peers like Meta have a clearer trajectory toward sustainable growth.
Returning tons of capital to shareholders
Alphabet's increasing competition shouldn't overshadow its impeccable capital return program. In the recent quarter, Alphabet spent $17.5 billion on its capital return program -- consisting of $15.07 billion in buybacks and $2.43 billion in dividends. It's nice that Alphabet is now paying a dividend, but buybacks are still magnitudes larger.
The run rate of the capital return program for a full year is about $70 billion, or 3.5% of Alphabet's roughly $2 trillion market cap. Meaning that if Alphabet only paid dividends and didn't repurchase stock, it would yield 3.5%.
Buybacks have a major impact over time because they reduce the outstanding share count -- thereby increasing EPS. Dividends, by contrast, are a one-time benefit, and shareholders must pay taxes on dividends in non-retirement accounts.
Over the last five years, Alphabet has reduced its share count by a staggering 10.9%. That's nearly as much as Apple's 12.3% reduction -- and Apple is known for its aggressive buybacks. Buybacks have allowed Alphabet's EPS to grow much faster than net income -- giving Alphabet a dirt cheap valuation.
Too cheap to ignore
Out of the "Magnificent Seven" companies -- Apple, Microsoft, Nvidia, Amazon, Alphabet, Meta Platforms, and Tesla -- Alphabet has the lowest price-to-earnings (P/E) ratio at just 17.7 and price-to-free-cash-flow ratio at 26.2.
Alphabet's cheap valuation reflects investor skepticism on its ability to monetize artificial intelligence relative to other megacap growth companies. But that doubt is arguably baked into Alphabet's valuation.
A 17.7 P/E ratio isn't just low -- it's a bargain-bin level for a high-margin company that continues to grow at an impressive rate. For context, safe and stodgy dividend-paying Procter & Gamble has a P/E ratio over 25. That's no knock on P&G, as it deserves a premium valuation. But P&G doesn't have Alphabet's growth prospects or margins.
A balanced buy at a compelling valuation
Alphabet is typically viewed as a growth stock, but its earnings multiple puts it in value stock territory. The dividend yield of 0.5% is misleading, considering Alphabet spends the bulk of its capital return program on buybacks.
Alphabet is priced as if it is doomed to margin compression and lost market share -- when its results indicate the opposite. Investors are getting a phenomenal opportunity to scoop up shares of Alphabet while they are stuck in the bargain bin.
However, if you do buy Alphabet, it is worth keeping a tight watch over its capex, its ability to take market share from other cloud competitors, and the resiliency of Google Search in the face of mounting competition.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
