This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) has been one of the most hated big tech stocks in the market over the past year. Despite posting consistently solid results, the market doesn't respect Alphabet's current business out of fear of what could happen to it. The primary question revolves around how Alphabet's legacy business (Google Search) will fare with the rise of generative AI.
Investors are assuming that Google Search revenue will tumble, taking Alphabet's stock with it. However, that hasn't happened, and I doubt it will. I think Alphabet can deliver shareholders monster returns over the next two years through a combination of a few factors.
Alphabet's stock is far cheaper than its peers
Alphabet trades at a significant discount to other members of the "Magnificent Seven" cohort on a forward price-to-earnings (P/E) basis (Tesla has been removed from this chart because it trades for more than 160 times forward earnings).
GOOGL PE Ratio (Forward) data by YCharts
Now, some stocks deserve a premium valuation, such as Nvidia, because it is growing its revenue and earnings at a rapid pace. However, I'd argue that other companies, like Microsoft and Apple, don't deserve nearly the premium due to their growth rates.
During the first quarter, Alphabet's growth rates, both in terms of revenue and earnings per share (EPS), were quite strong (I omitted Nvidia from this chart due to its rapid growth skewing the data).
GOOGL Operating Revenue (Quarterly YoY Growth) data by YCharts
Alphabet's revenue growth was in the middle of the pack, but much closer to second place than it was fourth place. Additionally, its EPS growth was the second-best of the five companies.
If I presented you with this information alone, you'd assume that the multiple Alphabet assigned should be in the middle to high end of this cohort's range. However, it trades at about a 50% discount to the second-cheapest member of the cohort, Meta Platforms.
So, what could happen if Alphabet receives a respectable multiple?
Alphabet could provide monster gains if it rises to an average valuation
The remaining four companies in the analysis (Microsoft, Apple, Meta Platforms, and Amazon) trade for an average of 31.3 times forward earnings. Should market conditions remain the same and Alphabet climb to 31.3 times forward earnings to be at the average valuation, the stock would rise by 68%.
Now, that 68% doesn't include any growth that Alphabet will experience over the next few years; that's just for reaching the same valuation level as its peers. This will be a tall task to accomplish, as the market appears to be convinced that Alphabet will face some challenges ahead. However, I think it's underestimating the staying power that Google has and how the average person will be perfectly content using Google's AI search overviews for their AI model. This should keep Google at the top of its game and allow it to continue growing its revenue at a steady double-digit pace for the foreseeable future.
It may take a few years for the market to come to its senses regarding Alphabet stock, but it will be a significant outperformer if it does. As another fun fact, if Alphabet were assigned a 31.3 times forward earnings multiple at today's prices, it would be tied with Microsoft as the second-largest company in the world by market cap.
Alphabet appears to be one of the top big tech companies to buy today. It's posting just as good as results (if not better) than its peers, yet trades at a huge discount. If Alphabet can continue posting strong results, the market will eventually come around to see that Alphabet is worthy of the same premium as its peers. By buying today, you can take advantage of a large discount and enjoy significant returns as Alphabet's valuation rises to match that of its peers.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
