Alphabet Inc (NASDAQ:GOOGL) is one of the most popular stocks among hedge funds and active managers. There were 128 hedge funds in Insider Monkey’s database with bullish positions in GOOGL shares. One of the funds that is bullish on Alphabet Inc is Wedgewood Capital which released its 2017 Q3 investor letter recently (you can download a copy here). Here is what Wedgewood Capital said about Alphabet Inc (GOOGL):
Alphabet has been in portfolios continuously since 2007, as the Company has invested in and developed more than a half-dozen digital content platforms, each with over 1 billion monthly users, to form the backbone of what is now the largest advertising franchise in the world. The Company continues to extend its lead, evidenced in its over 20% constant currency revenue growth for the June quarter, while generating 15% adjusted operating income growth. While traffic acquisition costs (TAC) to Google properties rose during the past few quarters, historically the Company has not managed margin trends as closely as they have revenue growth, and we would expect TAC growth to moderate over the next several quarters.
Alphabet continues to carry one of the strongest balance sheets in Corporate America, with nearly $100 billion in net cash and investments, a byproduct of the Company’s attractive profitability profile, which is on pace to generate $25 billion per year in free cash flow, along with a de minimis payout ratio. We do not think Alphabet needs this level of cash on its balance sheet to sustain its growth or value proposition, and we would expect the Company to eventually begin returning it to shareholders. We think this should benefit existing shareholders, as a new class of income-oriented investors is brought into the ownership fold.
We continue to hold Alphabet at a roughly weighted 6% in portfolios, roughly in-line with where it’s been for the past several years though, admittedly, below the 7% to 8% weightings of 2012, which saw the stock trade close to just 10X forward earnings on business model fears. Though Alphabet’s multiple has expanded quite a bit since those fearful days, it still remains attractive, particularly given its financial strength and continued high-teens revenue and profitability growth.
Alphabet Inc is one of the largest companies in the world. We don’t disagree with Wedgewood about the huge cash pile of Alphabet Inc or the large amount of free cash flow generated every year. One concern we have is that all of this good information might already be reflected in Alphabet’s stock price. Would you feel comfortable paying $700 billion to buy a company that’s generating $25 billion in FCF? I loved the stock when it was trading at 11 times its earnings and doubled my investment by sticking with it for a while, but it is a bit rich for me at the moment. What do you think?