In Q2, Bill Ackman’s Pershing Square directed its buying power at two mega-cap tech businesses, namely Alphabet and Amazon. Ackman added about 925,000 shares to his holdings of Alphabet Class A (NASDAQ:GOOGL). Combined with a large stake of Alphabet Class C (NASDAQ:GOOG) shares, this brings Alphabet to account for about 21 percent of the Pershing Square portfolio. Why is Ackman buying Alphabet stock, and could Alphabet still be attractive for investors right now?
Why Alphabet Is a Natural Ackman Pick
Bill Ackman’s investing strategy focuses on identifying simple businesses with wide competitive moats that can perform well under both positive and negative market conditions. As the parent company of Google, Alphabet enjoys one of the widest moats imaginable. Even with a slight resurgence of Bing in recent years, Google is still the overwhelmingly dominant search engine with a global market share of roughly 90 percent.
Beyond its core search engine business, Alphabet also enjoys a dominant position in the online video content space with YouTube, its second-largest source of revenue after Google ads. The business is even staking a significant claim for itself in the emerging AI space. The Gemini chatbot, Alphabet’s answer to ChatGPT, currently holds a roughly 13 percent share of the US chatbot market. Though small compared to ChatGPT’s almost 60 percent share, Gemini has been acquiring users at a rapid pace this year and will likely remain a meaningful competitor in the AI market for the foreseeable future.
Alphabet’s businesses also have high barriers to entry, another characteristic Ackman values. Google and YouTube established their respective leads in the early days of the internet and have only grown more dominant over the years, making them essentially impossible to replicate today. Alphabet’s AI play is a much newer endeavor, but only a handful of peers among the mega-cap tech firms can match Alphabet’s spending on AI infrastructure. As such, Alphabet enjoys dual barriers to entry in the forms of both powerful brand advantages and prohibitive costs for would-be competitors.
Alphabet also fits all of the financial criteria Ackman is known to look for in his stocks. Specifically, Ackman famously prefers businesses with high returns on invested capital, the ability to generate strong free cash flows and limited need to raise capital externally. Balance sheet strength is also a major factor for Ackman, as businesses with too much debt relative to their size can limit their own financial flexibility and present significant risks for the investors who buy them.
In the last 12 months, the tech giant has delivered a return on invested capital of 32.0 percent, closely mirrored by a return on equity of 35.1 percent. As of the end of Q2, Alphabet had also delivered a trailing 12-month free cash flow of over $67 billion. Even with the enormous amount that the business has spent on building its AI infrastructure, Alphabet also still has a huge stockpile of over $95 billion in cash, cash equivalents and marketable securities.
A final item on Ackman’s checklist is quality management, something that Alphabet is famous for. Alphabet has successfully scaled into a $3 trillion behemoth while maintaining a comparatively flat organizational structure that promotes innovation. Management also has a remarkable track record of creating shareholder value, as evidenced by the strong gains the stock has delivered over many years and throughout a variety of different market environments.
Put together, Alphabet’s characteristics make it something of a natural addition to Ackman’s portfolio. Few businesses can match its moat, barriers to entry, financial performance or balance sheet strength. Ackman was also able to lock in a much lower cost basis by buying GOOGL shares beginning in 2023. All told, Pershing Square has almost doubled its money on its GOOGL position.
Is Alphabet Still Worth Buying?
While Ackman has owned Alphabet since early 2023, the stock could still be attractive for new shareholders in today’s market. To begin with, Alphabet is still delivering very strong growth on both its top and bottom lines. In Q2, for example, revenue rose 14 percent year-over-year to $96.4 billion. Net income growth outpaced even that attractive rate, rising 19 percent from the year-ago period to $28.2 billion. These trends have held strong over multiple years, with Alphabet’s streak of revenue growth currently at 20 consecutive quarters and its earnings growth streak standing at nine quarters.
Even more importantly, it doesn’t appear that Alphabet is in for a slowdown anytime soon. Analysts expect EPS to keep growing at an annualized rate of about 15.5 percent through most of the rest of this decade. With organic growth from its search, video and cloud businesses and new opportunities emerging in AI, Alphabet could keep delivering market-beating growth for its shareholders into the 2030s.
Though they trade at a bit of a premium, GOOGL shares are also surprisingly cheap when compared to some of the other mega-cap tech businesses among its peers. The stock currently trades at a price-to-earnings ratio of 26.7 and a price-to-sales ratio of 8.3. The price-to-operating-cash-flow ratio of 46.3 is substantially higher, but it’s likely still reasonable for an extremely high-quality business with Alphabet’s growth potential.
Alphabet is even directing large amounts of its cash back to shareholders. Through the first half of this year, management allocated $28.7 billion to share buybacks and nearly another $5.0 billion to dividend payments. Though Alphabet’s dividend is still quite small at just $0.21 per quarter, the stock could become a dividend growth engine as the business’s cash flows continue to build.
Together, these factors form a compelling argument for buying Alphabet. Between what’s likely a fair valuation and strong growth prospects ahead, Alphabet could be as attractive to individual investors as it is to a large fund like Pershing Square. Though Ackman has the advantage of having started buying Alphabet when share prices were much lower than they are today, there could still be substantial value left in the Google parent company for shareholders looking for long-term buy-and-hold opportunities.
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.