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SUMMARY
Parkev Tatevosian, CFA, presents a detailed discounted cash flow valuation of Alphabet (GOOG) stock, comparing its intrinsic value to the current market price. He concludes that while Alphabet is not undervalued, it remains a solid buy for long-term investors due to its quality and fair pricing.
MAIN POINTS
- An overview of the discounted cash flow (DCF) model is introduced to assess Alphabet's fair value.
- The weighted average cost of capital and capital asset pricing model are explained as key components in the valuation.
- Forecasts show a significant drop in Alphabet's free cash flow in 2026 due to major capital expenditures, followed by a recovery and long-term growth.
- Key assumptions for the DCF model are detailed, including discount rate, cost of debt, cost of equity, and market risk premium.
- The intrinsic value per share is calculated at $354, below the current market price of $388, indicating the stock is not undervalued.
- Despite the lack of undervaluation, Alphabet is considered a buy due to its status as a high-quality business trading at fair value.
DETAILED ANALYSIS
The analysis begins with a step-by-step breakdown of the discounted cash flow (DCF) model used to estimate Alphabet's intrinsic value. Forecasts for free cash flow are projected annually from 2024 through 2034, with a terminal value calculated for 2035 and beyond. The model incorporates the time value of money by discounting future cash flows to their present value, using the weighted average cost of capital (WACC) as the discount rate.
The WACC is derived from a blend of the company's after-tax cost of debt, estimated at 5.5%, and the cost of equity, calculated at 10.9% using a beta of 1.05, a risk-free rate of 4.6% (based on the 10-year government yield), and a market risk premium of 6%. The capital structure assumption is set at 25% debt and 75% equity.
A notable feature of the forecast is a sharp decline in free cash flow in 2026, attributed to nearly $200 billion in capital expenditures, followed by a gradual recovery and resumption of growth at approximately 13% annually from 2029 onward. The H-model is applied to reflect higher growth in the near term, tapering off as the company matures and the benefits from artificial intelligence investments stabilize. The analysis emphasizes that DCF outcomes are sensitive to input assumptions, particularly the market risk premium; for example, lowering the risk premium from 6% to 4% would significantly increase the calculated intrinsic value per share.
Based on the current assumptions, the intrinsic value of Alphabet is determined to be $354 per share, compared to a market price of $388. While this suggests the stock is not undervalued, the difference is within a reasonable margin of safety (5-10%). The conclusion is that Alphabet, as a high-quality 'Hall of Fame' business, offers a fair deal for long-term investors even at current prices.
LINKS
- Special offer for The Motley Fool Stock Advisor.
- Parkev Tatevosian's book on evaluating publicly traded companies.
- Fiscal.ai investment research platform with a viewer discount.
- Webull investing platform sign-up with bonus shares.
- Subscribe to Parkev Tatevosian's free monthly Substack newsletter.
- Join Parkev Tatevosian's YouTube channel membership for exclusive perks.