Justin Sullivan/Getty Images News

Justin Sullivan/Getty Images News

Down 28% year to date, Google (Alphabet) (NASDAQ:GOOG , NASDAQ:GOOGL ) has been in my buy range for quite some time. Whenever I dig into the growth at a reasonable price (GARP) side of my portfolio, it's time to put on my Peter Lynch glasses. The stock has been growing earnings very consistently over time, both organically and through acquisitions. This is also a stock that quite a few fund managers that I follow have large positions in. We will both dig into a few 13-F filings and explore possible acquisitions in a down market. The elite group of tech behemoths has substantial cash positions on their balance sheets. Swooping up deals on Covid IPO unicorns that have fallen on rough times should be on the table in my opinion. My thesis is Google is a buy, I am accumulating this stock in tandem with my other GARP darlings.

First up is Joel Greenblatt's Gotham fund. Here we can see Google rounding out the top 5 just after Apple. In a previous article, I noted that on a recent episode of Richer Wiser Happier with William Green, Joel Greenblatt opined on what he believed were his top 3 "strongest companies he's ever seen". Amazon (AMZN), Microsoft (MSFT), and Google were the three that fall into that bucket. For those unfamiliar with Greenblatt, he ran a smaller fund in the mid-80s to mid-90s that achieved nearly 50% returns per year. He wrote several value investment classics and created the Value Investors Club to give a forum for amateur investors to collaborate on their ideas. He is also well known for discovering Dr. Michael Burry and funding Scion.

One of Greenblatt's main premises is he loves high returns on invested capital and a good earnings yield. The companies he mentioned have maintained high ROICs for years. This is a form of growth at a reasonable price as the return on invested capital being high almost always equates to substantial earnings growth.

Next up is Bill Miller's Value Partners fund. Here we can see Google rounding out the top 8. Bill Miller is famous for crashing and burning during the late 2000s and resurrecting himself like a phoenix from the ashes thereafter. He has been known for running concentrated positions. His personal portfolio is all Bitcoin and Amazon, however, his fund is much more conservative and has several flexible value philosophies:

Value investing means really asking what are the best values, and not assuming that because something looks expensive that it is, or assuming that because a stock is down in price and trades at low multiples that it is a bargain ... Sometimes growth is cheap and value expensive. . . . The question is not growth or value, but where is the best value ... We construct portfolios by using 'factor diversification.' . . . We own a mix of companies whose fundamental valuation factors differ. We have high P/E and low P/E, high price-to-book and low-price-to-book.

His number one bet is a put on (TLT), the iShares twenty-year treasury long bond fund. He is bullish that the FED will continue to raise rates. He, therefore, has not accumulated Google shares lately as this would indicate a mindset that long-duration or high p/e stocks will get hit as the risk-free rate increases. I would argue at these prices, Google is getting close to short duration.

Finally, we have Seth Klarman's 13F for the Baupost fund. He is a contemporary of Greenblatt and wrote the short print infamous Margin of Safety. The book had such a short run that copies on Amazon have gone for up to $5,000. There are digital versions, but it is certainly a collector's item to get your hands on a copy.

Klarman can be seen as the most conservative of the bunch, he has been recently plunking bet after bet into Liberty Global Plc (LBTYK), a flailing UK-based media conglomerate with a price-to-earnings multiple of 2.3X! Google is the highest weighted big tech position in Baupost. This certainly is encouraging in my opinion.

All the preceding value investors have not been quoted as hailing Peter Lynch as an influencer. However, using Lynch's guidance on the PEG ratio has been my primary identifier for good growth deals in the stock market. If you're not familiar with Lynch, he ran the Magellan Fund and Fidelity from 1977-1990. The Fund had the best 10 + year stretch ever at nearly 30% returns!

One bucket of Peter Lynch's portfolio was in growth stocks that had low PEG ratios, comparing the P/E ratio to its growth rate in earnings. You would simply calculate the trailing 3-5 year CAGR in earnings per share, drop the percent sign and divide the P/E ratio by that number, the further under 1, the better the deal. For setting a price target, we can find the compounded annual growth rate in earnings, drop the percent sign, and then use that as our multiplier and the trailing twelve months' EPS as our multiplicand.

Here is how Google pencils out. About 5 years ago, Google had an EPS of $2.21 a share. Since the year is getting close to being over, I will use the analyst average estimate for total 2022 EPS of $5.13 a share as the year 5 input.

This equates to a CAGR of 18.45%. If we use 18.45 as our multiplier times trailing twelve months' EPS of 5.23, we get an implied price target of $96.49. However, if we use the growth rate of EBIT, we get a growth rate of 22.74%. The TTM EBIT is $82.46 Billion. The EBIT per share with 13.04 Billion shares outstanding is $82.46/13.04=$6.32 EBIT per share. Using the PEG ratio adjusted to EBIT would give us a high-end price target of 22.74 X 6.32, or $143. If using EBITDA, the price target goes even higher. Although earnings have stalled and retreated a bit, both EBIT and EBITDA continue to grow.

Since Google and some of its other high ROIC tax-efficient brethren continue to compound at a higher rate internally, looking under the hood and drilling down on non-GAAP items is a worthwhile exercise. Google has invested $35 Billion in research and development TTM. Much like Amazon, this hides a lot of earnings, shelters them from tax, and spawns high-margin businesses that can later be added to the balance sheet and amortized. Triple win.

Furthermore, the EBITDA to FCF conversion rate and TTM free cash flow/ EBITDA is still solid. TTM EBITDA clocked in at $96.8 Billion, while free cash flow was $65 Billion, a conversion rate of 67%. Gross profit margins for the most recent fiscal year are at 56% vs an industry average of 55%, net profit margin is 29.5% versus 18.05% for the industry. Return on invested capital is still a monster at 28.94% to boot, straddling very close to the net profit margins.

Revenues are still growing. From 2012 on the left to TTM on the far right, we can see Google has grown revenues from $46 Billion to $278 Billion TTM. A CAGR of 19% revenue growth per annum that's still going. Even though bottom-line earnings pulled back a bit, top-line growth is still intact.

Cash and ST Equivalents (Seeking Alpha)

Cash and ST Equivalents (Seeking Alpha)

Looking at the balance sheet starting from Dec 2012 on the left to the last report on the right, we can see a huge influx of cash. Google has compounded its' cash position at 10% a year, from $47 Billion in 2012 to $124 Billion in the most recent report. The large cash position puts Google in a prime position to make acquisitions of long-duration, non-self-sustaining technology companies that popped up left and right during COVID through IPOs and SPACs when VC money was flowing like water and young investors were making it rain. Just as we now have better and better opportunities to buy stocks at a discount, companies that like to make a lot of acquisitions to grow their business like Google, Amazon, Meta (META), and Microsoft, all have ample dry powder to execute. The next couple of years should be a fishing expedition for that group, all trying to reel home the biggest grouper. I not only love these companies for their growth but also their cash.

One observation I made in a recent article about Amazon, was their large increase in property plant and equipment-related assets. From the above, we can see that Google is tracking the same trend. 2018 is on the right, pre-Covid, to the most recent report on the left hand of the balance sheet. We can observe that the value of tangible properties has increased by more than double during this time. Low-interest rates were one part, helping to grow their data center business, but a new law going forward might make Tech giants rethink their tax efficiency strategies as R&D will be capitalized and amortized versus expensed in the current year. A blurb from Amazon's most recent 10-K outlines this:

Effective January 1, 2022, research and development expenses are required to be capitalized and amortized for U.S. tax purposes, which will delay the deductibility of these expenses and potentially increase the amount of cash taxes we pay.

This will affect all the companies that operate on large R&D expenses. Most of them got out in front of this likely temporary and anti-inflation-geared policy. The depreciation expense from the COVID-built properties should continue to shelter a lot of earnings for years to come. Nonetheless, this may force these companies to also pay more taxes and show more net earnings, possibly a positive for share price but a negative for investors that want long-term internal compounding.

Google Balance Sheet ( Yahoo Finance)

Google Balance Sheet ( Yahoo Finance)

With only $28.8 Billion in debt and $125 Billion in cash and cash equivalents, Google could pay off all of its debt almost 4.5 X over. The debt-to-equity ratio of 11% is about as safe as it gets. This is probably the most conservative balance sheet of the tech giants with Meta being comparably conservative.

Not only do they have a lot of cash available for acquisitions, but the possibility to lever up and pursue new ventures is mind-boggling as well. A balance sheet like this in an innovative, basically self-perpetuating business makes the world their oyster. I believe lots of deals will abound with excellent technology companies on the verge of bankruptcy. So many promising companies have had their shares decimated. They won't want to sell more equity at low prices. Debt at high-interest rates would be suicide with negative cash flow. The best exit is going to be making a deal with a tech giant, driving the share price up near the agreed price per share, and letting everyone exit with a little cash in their pocket. Google buying someone like Palantir (PLTR) would be an awesome, synergistic business. That one would be a dream, but most likely not a reality.

From the most recent Google 10-K, here is a rundown of how they make money:

Performance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads.

Brand advertising helps enhance users' awareness of and affinity for advertisers' products and services, through videos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns

Google Play generates revenues from sales of apps and in-app purchases and digital content sold in the Google Play store.

Hardware generates revenues from sales of Fitbit wearable devices, Google Nest home products, Pixel phones, and other devices.

YouTube non-advertising generates revenues from YouTube Premium and YouTube TV subscriptions and other services.

Google Cloud Platform generates revenues from infrastructure, platform and other services.

Google Workspace generates revenues from cloud-based collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar and Meet.

Above are the primary revenue and income drivers of the business. Digital advertising, YouTube, and the cloud business are all very well-known and covered in articles. Recent Google presentations have been heavily focused on the cloud business with much of their R&D expenses allocated there. Google expects the TAM for cloud services to exceed $1 trillion by 2026. It was also recently announced, that Google is entering the chip market with Intel (INTC) for cloud-based semiconductors, currently called the E2000. This comes on the heels of Amazon and AWS' graviton chip. We can see that cloud computing is the main focus for these tech giants' R&D spending going into the future.

While the IP of the cloud can be considered intangible, the cloud infrastructure is anything but. Data centers are as large as logistics centers. As noted with the changes in R&D expensing tax laws, cloud computing is the perfect blend of both tangible and intangible that would seem most tax efficient in the current regulatory environment. This will provide both depreciation of real property and amortization of intellectual property while all of the spendings will benefit the focus of their research goals.

Advancements in the cloud are going to be the main catalysts for me. Whoever demonstrates the best margins, largest customer base and most efficient capital positioning for tax benefits will be the market darling when the tides turn around. There's plenty of room for Amazon, Google, and Microsoft to succeed in this space. I hold them all but still think Google is the cheapest valuation of the bunch.

Risks to the share price versus risks to the business are two different animals. The business in my opinion has near zero risk with a balance sheet like Google. The share price could continue to fall until P/E ratios dip below 15. With a price-to-free cash flow ratio of about 12.7 as of current, that number might be repriced to 10 by the market. Those numbers would be irrational for a company like Google, but I can imagine a few more rate hikes at 75 bps or worse will take all these names down a peg. To me, it's just more opportunity to accumulate. I just own this excellent business by virtue of the shares. The cheaper the better. I don't intend to sell.. ever.

Google is one of my long-term holds. The company has demonstrated excellent capital allocation, a very conservative balance sheet for a company with a $1+ trillion market cap, and amazing innovation. The changes in R&D expensing will hurt the short term, but I would hope the changes would be repealed once the government chooses to go back into inflationary mode. The hard asset empire Google built during covid will provide some nice depreciation expenses as well. Using a traditional PEG ratio with GAAP items only, I have a low price of $96.49 to a high price of $143 a share using a modified PEG to account for non-GAAP EBIT. GARP Diem, seize the day, Reiterate buy.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of GOOGL, AMZN, INTC, MSFT, AAPL, META either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.