Entering text into the input field will update the search result below

Google's Earnings Power As The Opportunity Cost Of Tech Investments

May 07, 2018 2:06 PM ETAlphabet Inc. (GOOG), GOOGLATVI, META, PANW, PYPL, TTD6 Comments
Investment Works profile picture
Investment Works


  • We share the details of our valuation of Alphabet on an Earnings Power Value basis, apply the IW Box framework, and reiterate our view that the investment opportunity is compelling.
  • We estimate Alphabet's earnings power yield (5.5% without Other Bets) and advance it as "the Google hurdle", or the opportunity cost for tech investments with similar growth prospects.
  • We recommend investors to avoid investments in tech businesses with similar or inferior growth prospects (mid- to high-growth rates, 20%+ ROC) that fail to clear the "Google hurdle".

As advanced in our initial take on Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), we believe that at about $1000/share, the investment opportunity is compelling.

Specifically, we wrote:

At $1000/share, we estimate that Alphabet is trading at about 1.25x Earnings Power Value (ex-cash and without "Other Bets"), that is, at a 25% premium of the net present value of the cash flows to shareholders, had management decided to stop investments in growth and distribute all FCF.

And argued that such modest premium over Earnings Power Value (EPV) was justified in view of "exceptional avenues of value-accretive growth".

In this piece, we share the thought process behind our estimation of EPV. Based on that estimation, we reiterate our view that at $1000/share, Alphabet offers a compelling investment opportunity.

We go on to claim that on an earnings power basis, Alphabet is significantly undervalued relative to most smaller tech companies with similar or inferior growth prospects. We thus advance Alphabet's earnings power yield, or the ratio of earnings power to enterprise value, as the opportunity cost for tech investments with similar growth prospects (mid- to high-teens CAGR, with returns on capital - ROC - in excess of 20%). We dub it the Google hurdle, since the yield is calculated neglecting the value of Alphabet's Other Bets.

We close with a recommendations for investors to reduce exposure, and avoid deploying new funds, to tech companies that do not clear the Google hurdle.

Sundar Pichai, CEO of GoogleSundar Pichai, CEO of Google (photo: Pradeep Gaur/Mint)

Google's earnings power

EPV is the hypothetical value of a business if it decided to stop investing in growth and maintained those zero-growth earnings in perpetuity.

It is a hypothetical estimation of value in that the business in question may well be investing in growth, which opens a gap between EPV and actual intrinsic value. In particular, a business investing

This article was written by

Investment Works profile picture
We are in a quest to redefine investment research, applying value investing to today's technologies and business models in search for asymmetric risk-reward.- Since its inception in 2015, the IW Portfolio has returned 206%, representing 38% annual compounded return and outperforming the S&P 500 by 153%, or 23% annualized (as of end Sept. 2018).- UPDATE: as of 2019, we have joined a larger investment outlet. We have discontinued invworks.com and the IW Newsletter as part of the agreement.To keep in touch, you can still follow me @ twitter.com/invworks

Analyst’s Disclosure: I am/we are long GOOGL, PANW, PYPL, ATVI, TTD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Recommended For You

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.