Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) derives approximately 80% of its revenue from advertising. But the company faces forces that could disrupt its business model and hurt GOOG’s stock. Ongoing legislation in the United States and regulatory measures in the EU could prevent Google from benefiting from its “gatekeeper” status with online advertisements.
For example, if you’re looking for a location, Google Maps might not be the priority option you use, as author Bohdan Kucheriavyi points out. Looking for Alpha. He says Google’s model could change forever and that it “[risks] lose a significant portion of their income.
It paints a pretty drastic scenario where Google could be hampered by these regulations. Nevertheless, he also points out that Alphabet fights against the implementation of these laws and regulations. They might not even come into force in the EU, where most of the risks now seem to lie.
Google’s fate is tied to the economy
The problem with Kucheriavyi’s analysis is that it does not model potential effects. One of the main factors is that online advertising continues to grow and take more and more market share from traditional sources. This fuels Google’s revenue model, regulation or not.
A second factor that has not been fully analyzed is the enormous elasticity effect of Google search. People trust Google search and Google products.
So, for example, how important will it be if the brand effect of Google Maps outperforms other location maps services or even other search services? Hard to believe that with the power of the Google brand effect and the inelasticity of demand, people won’t walk away.
Finally, analysts are still not worried. Let’s see what they are planning. Looking for Alpha shows that 41 analysts expect revenue to rise 15% this year to $298.18 billion. They also forecast 15% gains next year on revenue of $343.33 billion. This includes all their fears and adjustments for a possible recession.
Additionally, earnings per share (EPS) are expected to rise 18.75% to $133 per share. This puts the stock on a forward price/earnings (P/E) multiple of just 16.8x for next year. This is well below its historical average of 26.3x for its forward P/E over the past five years, according to Morningstar.com.
The reason could be that online advertising revenue is on a long-term upward trend. Even if Alphabet’s Google unit gets a lower market share in the future, the company’s revenue and profit could still increase.
Where does that leave investors in GOOG stocks
Alphabet does not pay a dividend, but the company plans to do a stock split on July 15. This could give GOOG stock a temporary boost as the price of $2,239.84 at the time of writing drops 20x to $111.99. Traders may push the stock closer to this moment assuming the lower price will encourage more people to buy the stock.
More importantly, Alphabet produces huge amounts of free cash flow (FCF). Last quarter, its FCF was $15.32 billion, as can be seen on page 7 of its quarterly earnings release. This leaves plenty of room for the company to redeem its shares.
For example, in the last quarter alone, it repurchased $13.3 billion of its stock. This equates to $53.2 billion per year and could likely be much higher if redemptions are viewed as a percentage of growing revenue.
In fact, on April 22, the company increased its buyback program to $70 billion. This equates to 4.93% of its $1.42 trillion market capitalization. This implies that there is an implied 5% gain in the stock price even before any EPS gain, multiple expansion or boost from the next stock split.
Finally, if we use Morningstar’s forward P/E of 26.3x the multiple, GOOG stock could rise 56.5% from its current forward P/E of 16.8x. Even at 20x, the stock would rise 19%. It shows that Alphabet is just too cheap here, despite fears of a changing regulatory environment for its Google unit.
As of the date of publication, Mark Hake did not hold (either directly or indirectly) any position in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.