Google parent company Alphabet (NASDAQ:GOOG, GOOGL) has been a stellar performer over the last year, with trailing 12-month returns of almost 75 percent. The question facing investors now, though, is whether Alphabet can keep this impressive run up. Today, let’s take a look at Alphabet to see where shares of the business behind Google could be in three more years.
What Do Analysts Expect From Alphabet?
Although Alphabet has already surged in the last year, analysts expect the stock to keep delivering solid gains over the next 12 months. The consensus price target of $359.53 represents a 17.5 percent upside from the most recent price of $306.01, and GOOG still holds a strong buy rating.
Looking a bit farther ahead, analysts also expect Alphabet’s earnings growth to remain strong through the next three years. EPS growth is expected to come in at an annualized compounded rate of 15.5 percent during that period. Starting from the current trailing 12-month EPS of $10.81, three more years of growth at this rate would result in earnings of around $16.60 per share.
Alphabet’s Growth Opportunities
While many businesses are looking to benefit from AI, Alphabet is among those that are perhaps best-positioned to profit from the technology. In Q4, Alphabet reported a 48 percent year-over-year increase in revenues from its Google Cloud business segment, which rose to $17.7 billion. This surge in cloud revenue, driven by AI, helped Alphabet achieve overall revenue growth of 18 percent to $113.3 billion.
Although cloud revenue is growing at the fastest pace, Alphabet also continues to see solid growth from both its core search business and YouTube. Search revenue increased by 17 percent in Q4, rising to over $63 billion. Although YouTube’s revenue growth in the fourth quarter was slower at 9 percent, the video streaming platform achieved over $60 billion in revenue for the full year.
Crucially, Alphabet retains strong competitive positions across its business lines, laying the groundwork for future growth. Google is by far the world’s dominant search engine, while YouTube has reportedly surpassed Disney to become the world’s largest media company. On the cloud front, Alphabet is less dominant due to competition from Microsoft Azure and AWS. By focusing heavily on AI, however, Alphabet has been able to fuel massive growth in its cloud segment and may be in a position to challenge Amazon and Microsoft’s moats over the coming years.
It’s also worth mentioning the fact that Alphabet’s business is a proven cash generator, enabling it to reinvest into both new growth initiatives and returning excess cash to its shareholders. Last year, Alphabet generated over $73 billion in free cash flow and repurchased over $45 billion worth of its own shares. This combination of massive FCF and a predisposition to buy back shares creates a virtuous cycle for long-term shareholders.
Cumulatively, these factors could create a compelling growth story for Alphabet. The large free cash flows generated from search and YouTube allow Alphabet to keep investing in its cloud segment, currently the fastest-growing driver of new revenues. In the period between 2024 and 2030, global cloud computing is expected to average an annual growth rate of 22 percent, reaching a total of $2 trillion by the start of the next decade. By seizing off a larger piece of this fast-growing pie while continuing to build its core businesses, Alphabet could deliver strong growth rates through the rest of the 2020s.
Will Alphabet’s Valuation Weigh It Down?
Another important point about Alphabet at the moment is the fact that the stock isn’t trading at the sky-high valuations commanded by some of the other top tech stocks. Shares of GOOG are currently trading at a trailing 12-month P/E of 28.3, slightly below the S&P 500 average of 29.2. Though not exactly a low multiple to earnings, this valuation likely won’t be enough to drag on Alphabet’s returns if its earnings keep growing as expected.
It’s also worth noting that high valuations haven’t tended to exert too much downward pressure on Alphabet stock in the past. Owing to growth tailwinds from the COVID-19 pandemic, GOOG shares spent much of 2020 and 2021 trading above 25 times earnings. Similar premiums were also fairly common throughout large parts of the 2010s. With this in mind, Alphabet’s current valuation doesn’t look too concerning, even though it is somewhat above the premium the stock has commanded for the past few years.
Alphabet’s price also seems to be supported by its very strong profitability metrics. In addition to a net margin of 32.8 percent over the last 12 months, Alphabet has been able to produce returns on invested capital and equity of 32.4 percent and 36.0 percent, respectively. Added to the large free cash flows and competitive moats mentioned above, these metrics demonstrate Alphabet’s almost unique qualities as a business.
So, Where Could Alphabet Be In Another Three Years?
Although it’s unlikely to replicate the massive gains of the last 12 months, Alphabet could offer attractive returns to investors over the coming few years. Assuming Alphabet’s premium to earnings doesn’t contract too much and its earnings per share grow as expected, prices of $425-$475 would be roughly in line with anticipated EPS growth. Using this rough estimated range as a guide, shares could appreciate by about another 50 percent over the coming three years.
It’s also worth mentioning the simultaneous dividend growth that Alphabet could deliver over the next few years. Though Alphabet is fairly new to paying a dividend, the same strong cash flows that support both ongoing investment and share buybacks could also be used to fuel cash returns to shareholders. Right now, GOOG only offers a yield of 0.3 percent, but the payout ratio of 7.5 percent leaves ample room for dividend increases. As such, Alphabet could also prove to be a decent long-term candidate for dividend growth.
Overall, GOOG still looks like it could be an attractive buy-and-hold at current prices. While much of the stock’s potential upside has already been priced in over the last 12 months, the growth opportunities of the next several years could still allow it to move steadily higher.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.