Why Alphabet Has More Than 25% Upside

As the parent company of Google, the most popular search engine in the world, Alphabet Inc. (GOOGLE) has growth potential that could lift its stock 25% or more. Despite recent talks of greater government regulation on companies like Facebook Inc. (FB), analysts believe the risks are not as great for Alphabet and are optimistic considering that overall spending growth on online advertising is only expected to increase. “You have to be on Google,” says founder and CEO of Gravity Capital Management Adam Seessel, if you run any kind of service-based business, which gives Alphabet “a chokehold on the global service economy,” as reported by Barron’s.

As of the close of trading on Tuesday, Alphabet is up 23% over the past year, but down nearly 13% since reaching a high at the end of January. In comparison, FAANG peers like Facebook is up 17% since a year ago and down 14% since reaching a high at the beginning of February, and Amazon, which is up 58% over the last year, but down about 10% since around the middle of March. (To read more, see: Alphabet, Facebook, Amazon: Now ‘Too Big to Fail’?)

Growth Potential

Despite its seemingly high valuation with a forward price-to-earnings ratio of 21.13 compared to the S&P 500’s forward multiple of 16.88, the potential for 15% to 20% annual growth in revenues and profits over the next three years gives strong support to the claim that Alphabet is trading at a relative bargain.

Taking the low end of that growth estimate, the company’s price-to-earnings-to-growth ratio (PEG ratio) is 1.41. Assuming a 3% GDP growth estimate for the U.S. economy, the PEG ratio for the broader economy with the S&P as the proxy for the broader market is 5.63. The gap in growth expectations makes all the difference, giving Alphabet an extremely attractive valuation. With a 62% stake in the $110 billion annual global search-advertising revenue, the 15% projected annual growth in the overall search market is where Alphabet’s primary growth potential lies. (To read more, see: Alphabet’s Stock Price May See a Sharp Rebound.)

Other Business Segments

But the attractiveness of the company’s valuation looks even better if one adds back the losses from Alphabet’s “nascent but promising businesses like Waymo, the leader in self-driving cars,” according to Barron’s. Waymo is also just one of Alphabet’s other valuable business segments in addition to Google. The company also owns Youtube and Android.

Adding up the value of these various business segments—a sum-of-parts valuation—analyst Anthony DiClemente at Evercore ISI gives Alphabet an Outperform rating and a price target of $1,300. Analyst Brian Nowak at Morgan Stanley values the company at $1,400 a share on a sum-of-parts basis. Those targets imply a 25% and 35% upside to Alphabet’s shares, respectively, based on Tuesday’s close of 1,036.50.