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Alphabet Stock Is Undervalued, But Upside Remains a Challenge for GOOGL

Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) stock has traded in the $1140-$1265 per share range since announcing earnings July 25. The company saw sales grow 26% year-over-year. With shares trading at a reasonable valuation, is Alphabet stock a buy? A rebound in the company’s flagship advertising business, along with growth in the cloud business, are strong catalysts going forward. But several risks remain on the horizon, which could mean downside to the GOOGL stock price.

Let’s take a closer look at GOOGL stock, and see what lies in store for the search giant’s shares.

A Closer Look at Alphabet Stock

Alphabet saw quarterly earnings in the second quarter of $14.21 per share. This beat expectations by $2.75 per share. As mentioned above, this was thanks to a rebound in the company’s advertising business. Sales bounced from $28 billion in Q2 2018 to $32.6 billion in Q2 2019. Alphabet’s non-advertising revenue saw even more impressive growth. Sales grew roughly 40% year-over-year, jumping from $4.4 billion to $6.2 billion.

Operating income was $9.2 billion, up from an adjusted $8.1 billion in the prior year’s quarter. With the market absorbing last month’s earning report, what’s the next move for Alphabet stock? Shares continue to be down from their 52-week high of $1296.98. Material upside could be a challenge. A myriad of risks could impact the GOOGL stock price.

Regulation and Competition Are Risks to GOOGL Stock Price

With about $50.8 billion in operating cash flow, the company has plenty of capital to boost shareholder value. While the company loses around $1 billion per quarter from their “Other Bets” growth initiatives, this is a mere drop in the bucket. With more cash than opportunities, the company announced a $25 billion stock buyback plan. This is modest compared to Alphabet’s market cap ($831 billion). As InvestorPlace contributor Todd Shriber discussed Aug. 15, Alphabet could easily plow their $121 billion of cash on hand into a massive buyback. This would really move the needle for GOOGL stock.

The GOOGL stock price faces downside risk from increased regulatory pressure. Last year’s $5 billion European Commission fine is just the start. In the U.S., politicians on both sides of the aisle want to rein in Alphabet. Additional movement by U.S. regulators will cause additional downside in the stock.

Beyond governmental regulation, Alphabet stock could face headwinds as the tech space evolves. While Google built a license to print money with search advertising, cloud computing is highly competitive. Rivals such as Amazon’s (NASDAQ:AMZN) Amazon Web Server rule the market. In this and other growth areas, GOOGL will not have the 80% market share they have in online search. Future growth opportunities will not be cash cows like search advertising.

With this in mind, is the current valuation of GOOGL stock justified? Compared to its “FAANG” peers — Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon, Netflix (NASDAQ:NFLX) and Google — Alphabet stock appears undervalued. But given the opportunities and risks, this valuation could be justified.

Shares Remain Undervalued Relative to FAANG Peers

GOOGL stock is a constituent of FAANG. Compared to this esteemed group of tech giants, GOOGL stocks trades at a discount. Alphabet stock currently has a forward price per earnings ratio of just under 22. The company’s Enterprise Value/EBITDA ratio is 16.3.

Here are the valuation ratios for the rest of the FAANG components:

Facebook: Forward P/E of 19.6 and EV/EBITDA of 18.1

Amazon: Forward P/E of 54.7 and EV/EBITDA of 27.7

Apple: Forward P/E of 16.5 and EV/EBITDA of 12.4

Netflix: Forward P/E of 54.9 and EV/EBITDA of 72.2

You can make the argument that GOOGL has less runway than NFLX and AMZN. But both are reaching the limits of scale themselves. Alphabet has the capital to chase the opportunities the rest of FAANG are targeting. Each of them has the opportunity, but not the edge, in dominating these markets. With Alphabet stock offering earnings today and growth opportunities tomorrow, it may just be the best of the bunch to own.

Bottom Line on GOOGL Stock

Compared to the other big tech high-flyers, GOOGL stock is a bargain. Shares trade at a slight discount to Facebook, and a substantial discount to Amazon and Netflix. But unlike the latter two, Google has matured to “cash cow” status. With more capital than they can put to work, Alphabet stock ne a big catalyst to move the needle.

Meanwhile, regulation and competition remain big risks. With Washington putting Alphabet in its crosshairs, the company could face substantial headwinds. The new frontiers of tech (cloud computing, artificial intelligence) are highly competitive. Alphabet will likely not find another cash cow to compliment their search advertising business. Both of these threats could cause material downside in the GOOGL stock price.

With these factors in mind, what’s the call? If you are looking for a growth stock with a reasonable valuation, consider GOOGL. But with the specter of recession just around the corner, investors may soon have the opportunity to enter GOOGL stock at a lower entry point.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.