With Analyst Estimates for Alphabet (NASDAQ:GOOG.L) Rising, the Stock Appears Undervalued, but the Discount may Remain

Alphabet Inc. ( NASDAQ:GOOG.L ) released very strong second quarter results last week. Quarterly revenue increased 62% year-on-year to $61.9 billion while net income increased 166% to $18.5 billion.  It’s not surprising to see that analysts have now upgraded their earnings estimates and price targets.

Notable highlights from the result included:

• YouTube Ad revenue up 84% to $7 billion. This is the fastest growing segment and accounted for 11% of total revenue.
• Cloud revenue increased 53% to $4.6 billion. This growth was well ahead of both Amazon’s AWS and Microsoft’s Azure. The operating loss for the cloud business decreased from $1.4 billion to $591 million.
• Alphabet's operating margin improved from 17% to 31%.
• Total revenue was 10% ahead of consensus estimates and EPS were 41% ahead of consensus. 

Source: Google Press Release

We've gathered the most recent statutory forecasts to see whether the analysts have changed their earnings models, following these results.

See our latest analysis for Alphabet

Consensus EPS estimates increase to US$101

The consensus outlook for earnings per share (EPS) in 2021 has improved.

• 2021 revenue forecast increased from US$236.5b to US$250.5b.
• EPS estimate increased from US$88.05 to US$101 per share.
• Net income forecast to grow 11% next year vs 9.8% decline forecast for Interactive Media and Services industry in the US.
• Consensus price target up from US$2,803 to US$3,127.

Taking into account the latest results, the consensus forecast from Alphabet's 36 analysts is for revenues of US$250.5b in 2021, which would reflect a meaningful 14% improvement in sales compared to the last 12 months. Per-share earnings are expected to rise 8.3% to US$101. Before this earnings report, the analysts had been forecasting revenues of US$236.5b and earnings per share (EPS) of US$88.05 in 2021. There's been a pretty noticeable increase in sentiment, with the analysts upgrading revenues and making a nice gain to earnings per share in particular.

With these upgrades, we're not surprised to see that the analysts have lifted their price target 11% to US$3,141per share. Fixating on a single price target can be unwise though, since the consensus target is effectively the average of analyst price targets. As a result, some investors like to look at the range of estimates to see if there are any diverging opinions on the company's valuation. Currently, the most bullish analyst values Alphabet at US$3,600 per share, while the most bearish prices it at US$2,480. This shows there is still a bit of diversity in estimates, but analysts don't appear to be totally split on the stock as though it might be a success or failure situation.

Looking at the bigger picture now, one of the ways we can make sense of these forecasts is to see how they measure up against both past performance and industry growth estimates. The analysts are definitely expecting Alphabet's growth to accelerate, with the forecast 29% annualised growth to the end of 2021 ranking favourably alongside historical growth of 18% per annum over the past five years. By contrast, our data suggests that other companies (with analyst coverage) in a similar industry are forecast to grow their revenue at 16% per year. It seems obvious that, while the growth outlook is brighter than the recent past, the analysts also expect Alphabet to grow faster than the wider industry.

Is Alphabet Undervalued?

Our estimate of Alphabet’s intrinsic value based on analyst forecasts is $4,575 - you can read more about the methodology here. That implies that the stock is trading at a discount to fair value of about 40%.

The PE ratio of 29 is significantly higher than the market's 17.8 PE, but close to the US Interactive Media and Services industry PE of 32.6. When we consider the PE in the context of historical and forecast growth rates the market doesn't appear overly optimistic about the stock.

Will the Apparent Discount Narrow?

Earnings estimates for Alphabet have been rising consistently for the past 12 months and Alphabet has good earnings momentum. In addition, the stock appears to be trading at a discount to its intrinsic value, and the market doesn't appear overly optimistic about future growth. That said there is one point we would like to make about the company's apparent discount to fair value.

Alphabet is a holding company that owns numerous companies, mostly within Google itself. Some of these, including YouTube, AdSense, Android, Google Cloud and  Waymo are very valuable in their own right. However, holding companies tend to trade at a discount as value is 'locked up' in the company structure. This may account for the slightly lower price targets analysts have set for the stock.

Alphabet's share price may well appreciate if earnings estimates continue to rise. However, the discount may remain until, or unless, it becomes likely that some of the assets will be unbundled. There is a lot of speculation that this will eventually happen, but for now it is just that - speculation.

The good news is that the stock doesn't be overvalued and Alphabet's long term growth prospects look good. We have forecasts for Alphabet going out to 2023, and you can see them free on our platform here.

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Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.