Are Google shares significantly undervalued?

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Google’s parent company Alphabet (NASDAQ: GOOGL) has put on a stellar performance so far this year. As one of the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google), it has one of the largest market caps in the world at $1.8trn. These companies are now individually richer than most countries on Earth. Google shares reached an all-time price high of $2,736 yesterday, and I predict the stock could easily rise further.

Second-quarter earnings

Alphabet released Q2 earnings on 27 July. The stock leapt 3% as every Alphabet division reported record growth. Overall revenue came in at $61.9bn for the quarter. This was 62% higher than the same quarter last year, thrashing analyst expectations. Profits more than doubled to $18.5bn. CEO Sundar Pichai believes that this record growth was largely due to “a rising tide of online activity in many parts of the world.”

Search and advertising

Google’s core business is Google Services, which incorporates search and advertising. Even with a slowdown in global advertising spending, it was still able to massively grow revenue. Google Services generated $22.3bn in Q2 income, yielding an operating profit margin of 39%. In the same quarter in 2017, the margin was 29%, meaning that Google Services has increased profitability by 10%. As the business grows, I think margins are likely to become even more profitable, making Google shares significantly undervalued.

Google Services also includes YouTube, with advertising revenue up 84% in Q2 to $7bn. YouTube creators were paid more money in Q2 than in any previous quarter, and Alphabet is investing heavily to shrug off competition from the likes of Facebook-owned Instagram. With YouTube comprising only 11% of overall revenue, there is plenty of room for growth. However, as the world comes out of lockdown, it seems unlikely that this meteoric rise can continue.

Google Cloud

The growth of Google Cloud is another success story, with Q2 revenue increasing 54% to $4.6bn. The division now makes up 7.5% of total Alphabet revenue. Very few companies have the financial clout to set up secure cloud computing services. Google will therefore find plenty of market space to expand, even competing against the likes of Amazon and Microsoft. It’s worth noting that Google Cloud still made a loss of almost $600m in Q2, so I believe future increased profitability of Google shares is a bet on out-competing other services.

Time to buy Google shares?

As a long-term investor I value diversification of risk in my portfolio. Alphabet is also investing in AI through its DeepMind division, and in self-driving cars through Waymo. While these divisions are currently loss-making, Alphabet has the resources to absorb losses for the possibility of future returns.

The company completed $24bn of share repurchases in the first half of 2021, driving publicly available shares from 696m in 2019 to 667m today. It’s also cash rich, with a reported balance of over $100bn. There’s plenty of momentum behind its all-time share price high.

There are risks though. Competitors are always nipping at its heels. There’s also potential legal hurdles to clear, with anti-trust lawsuits that could see the company broken up into smaller pieces. Its share price has plenty of room to fall. However, Google shares are still significantly undervalued for me.

The post Are Google shares significantly undervalued? appeared first on The Motley Fool UK.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Charles Archer owns shares of Alphabet (C shares), Amazon, and Netflix. The Motley Fool UK owns shares of and has recommended Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Facebook, Microsoft, and Netflix. The Motley Fool UK has recommended the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.