In its most recent 13F filing, Warren Buffett’s Berkshire Hathaway conglomerate revealed a surprisingly large new investment of $4.9 billion in Alphabet (NASDAQ:GOOG, GOOGL). Although Buffett typically avoids tech stocks, the decision to buy Alphabet may be among the last he participates in at Berkshire before stepping down at the end of the year. Why did Warren Buffett buy the Google parent’s stock, and does Alphabet still look like it could be a good buy today?
The Role of Alphabet’s Trading at 28x Earnings
Where Berkshire Hathaway is concerned, it’s usually a good idea to look at a stock’s valuation as a key factor in buying and selling decisions. Even after receiving a boost from the news that Berkshire had taken a large position in it, Alphabet is still only trading at about 28.2 times its trailing 12-month earnings.
While this still represents a premium compared to the broader S&P 500, it’s well below the multiples commanded by some of its other high-growth Magnificent Seven tech peers. For reference, NVDA is still trading at over 53 times earnings, while MSFT has a P/E of over 36. Considering these metrics, Alphabet may actually be among the most reasonably priced of the large tech businesses at the moment. Even more importantly, its more reasonable valuation may also make it more resilient in the increasingly likely event that the market sells some of the priciest AI stocks off due to perceived overvaluation.
Alphabet’s 12-Month FCF Is Massive
One of the positive characteristics of Alphabet that may have most appealed to Buffett is its massive free cash flow. In Q3’s earnings report, Alphabet detailed trailing 12-month FCF of over $73 billion, including $24.5 billion generated in Q3 alone. This FCF was accompanied by consolidated revenue growth of 16 percent to $102.3 billion and net income growth of 33 percent to just under $35 billion.
Though Alphabet’s high free cash flow is extremely prominent, it’s far from the only financial metric that may have drawn the Berkshire Hathaway team to invest in the business. Alphabet boasts a trailing 12-month net margin of 32.2 percent, alongside a return on equity of 35.8 percent. Returns on invested capital and assets, meanwhile, stand at 32.7 percent and 26.0 percent, respectively.
On top of its excellent trailing performance, Alphabet is also likely to maintain a high rate of growth for the foreseeable future. 2026 is expected to see substantial CapEx growth from Alphabet as it builds infrastructure to meet quickly rising demand for cloud computing. Between this, its massive ad business and its large presence in AI, analysts are expecting EPS growth of roughly 15 percent annually over the course of the next five years.
Alphabet also enjoys what amounts to an ironclad moat in the world of online search. Although there’s some speculation that AI chatbots may begin to encroach on Alphabet’s dominance, Google’s global market share among traditional search engines still stands at 90 percent. With over 16 billion searches conducted on Google every single day, the search engine remains a vital tool that is used by most of the world’s population daily to find and access online resources. Even after years at the top of its field, revenue from the search engine rose by 14.5 percent in Q3 to a total of $56.6 billion.
A final piece of the puzzle may be Alphabet’s increasingly prominent habit of directing the cash generated through its business back to shareholders through a combination of buybacks and dividends. In the first nine months of the year, Alphabet repurchased over $40 billion worth of its own stock. The business is also among the large tech businesses that have started to pay a dividend, though the stock’s yield is still well under 1 percent due to the dividend being quite new. Even so, Alphabet’s free cash flow could make it a decent candidate for dividend growth over many years.
Buffett’s Own Reflections on Alphabet
With Warren Buffett gradually stepping back ahead of his planned retirement at the end of the year, it’s likely that other members of the Berkshire investing team put in most of the work on the decision to buy Alphabet. With that said, Buffett has personally commented on the business many times over the years.
Buffett has revealed that he considers not investing in Google early on one of his significant investing mistakes, as SEO efforts at GEICO allowed him to see early on how valuable dominance in the search engine category could be. Buffett has also lauded Alphabet’s business model, specifically referencing its returns on capital and assets with low need for additional capital to drive growth. Given these statements, it’s likely that Buffett has been mulling an investment in Alphabet for quite some time and may have been waiting for an attractive buying opportunity.
Why Buffett Finally Bought Alphabet
Putting all of these factors together, it’s not difficult to imagine why Buffett and his team at Berkshire finally decided to open an Alphabet position. With an almost impenetrable moat, huge free cash flows and a capital-light model that allows it to earn large returns on its assets, equity and invested capital, Alphabet has many of the features that Buffett has historically looked for in great businesses. Although shares aren’t exactly cheap, Alphabet may also be trading at a decently low price when its long runway for future growth is taken into account.
The fact that Buffett has been looking at Alphabet for many years likely also played a contributing role. Judging from his past comments, Buffett has understood for years that Alphabet is a high-quality business with many of the characteristics he typically prioritizes. Getting to watch the business over such a long period of time may have alleviated any lingering concerns Buffett had about Alphabet’s moat.
Ultimately, Alphabet appears to closely fit Buffett’s classic stock-picking criteria, even though it does have the unusual characteristic of being a tech business. Considering the growth Alphabet is expected to deliver and its probable long-term dominance in online search, it’s quite likely that the decision to buy the stock will result in solid gains for Berkshire in the long run.
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.