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Google/Alphabet – still searching for a breakout?

As Google celebrates its 18th birthday, and the share price of Alphabet - the parent company - sits near all-time highs, it might be time to ask whether the shares are still a good investment.

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Alphabet overtook Apple to become the most valuable company in the world in February of 2016. The stock of both companies took a dive in mid-year, with both down around 10%, but since then these two icons of the new world economy have rallied, with Apple moving ahead with a gain of 8% compared to Alphabet’s 4% (as of 29 September). Revenue-wise, Alphabet lags behind Apple, with the former generating $75 billion for 2015, while the latter posted revenue of $234 billion. Net profit margins for both are largely similar at 21.8% for Alphabet versus 22.8% for Apple.

However, it is important to remember the stock market is forward-looking, and so it is the revenue growth rates that command attention rather than just the absolute numbers. Apple’s growth rate was 28% for its 2015 financial year, compared to just 14% for Alphabet. However, while this might seem to give the advantage to Apple, it is going to prove difficult to sustain such growth, especially since the best years of its iPhone sales may be behind it.

Alphabet appears to have a competitive edge in its market, with a clear dominance in search engines. In addition, its Android smartphone technology has made it a direct competitor to Apple. Apple’s relative dominance in smartphones is likely to decline, even if it retains an overall lead, so here too the future looks brighter for Alphabet than Apple. Admittedly this does not automatically make Apple a bad investment, since its well-integrated vertical business model means it has a powerful edge in retaining customers, who buy into the entire Apple ecosystem when they purchase an iPhone.

The major problem for Apple is it has not produced a new product that can match the impact created by the iPhone and its subsequent iterations. Instead, it has relied on improvements and similar products, such as iPads and the infamous Watch. Now, it is looking to boost its recurring revenues, through enhanced services provision. This, however, will take time, and these new sources of revenue do not look secure.

By comparison, investors have a good idea about possible sources of income for Alphabet, including its cloud services, Verily, Calico and others. At present, these are losing money, but as with Amazon, Alphabet investors have opted to take the long view. At least Alphabet has diversification, whereas Apple has yet to move meaningfully away from the iPhone.

Crucially, when we look at Alphabet, we can see a valuation that is not too demanding, and does not assume too much ‘good news’ in the future. Indeed, compared to some tech firms, a forward price/earnings ratio of 19 looks positively cheap. The S&P 500 itself trades around this valuation level, and that includes many older companies whose growth rates will never match Alphabet’s. Combined with a whopping $6.9 billion in free cash flow last year, which itself was up 53% year-on-year, and a cash pile of $78.5 billion, Alphabet seems to have a bright future.

From a chart perspective, Alphabet provides interesting possibilities. Since December of 2014, the trend has been firmly upwards, with dips in July 2015 and June 2016 both running right into the rising trendline before rallying once again. So far the area around $820 has acted as powerful resistance, with attempts to break this running back to October 2015 all ending in failure. In August and September 2016, the stock price has clung closely to $820, so it could be gearing up for a breakout to new all-time closing highs. This could clear a path to the all-time intraday high at $850. Any sell-off could head back to the rising trendline, perhaps seeing a dip to $730 before the rally begins anew. 

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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