Where to turn in a scary market
With the Nasdaq Composite down more than 20% so far this year and the stock market's violent reaction to Fed Chair Jerome Powell's speech on Friday, it might be tempting to sell stocks. But study after study has shown timing the market doesn't work.
That's why factors like a dominant market position, a reasonable valuation, or a shareholder-friendly management team can provide the confidence to hold on during a downturn. Only a select few companies offer all three attributes. That's why Alphabet (GOOGL -1.45%) (GOOG -1.55%) will be the next stock I add to my portfolio.
Image source: Getty Images.
1. When a brand becomes synonymous with the product
Pass a Kleenex. Xerox the report. Put a Band-Aid on it. You know a brand is dominant when consumers are using its name in place of the actual product. Googling something might be the best example of this phenomenon. Definitive numbers aren't made public. But it is estimated that more than 63,000 searches per second -- about 5.6 trillion per year -- are conducted through the Google search engine. Statista pegs its global market share at around 84%. That is absolute dominance.
Of course, it is just one arrow in the company's quiver for gathering data to serve up targeted advertisements. It has nine products that command more than one billion users. Searches made up 57% of the $182 billion in 2021's revenue. Advertising overall -- through products like YouTube, Gmail, Google Maps, and its app store Google Play -- accounted for 80%.
Skeptics worry about legislation that could hamper the company's stronghold. But the most recent attempt, the American Innovation and Choice Online Act, appears to have missed its window in Congress. With mid-term elections approaching, it's unclear when that window might reopen. For now, the company appears safe from additional regulation.
2. Eventually, valuation matters
It's not clear who first said, "Valuation doesn't matter...until it does," but they should be taking a victory lap. After years of historically high valuations and a stimulus-fueled crescendo, most stocks are now trading at multiples of sales, cash flow, and earnings that are more in line with historical norms. As we entered 2021, the S&P 500 traded at a price-to-earnings (PE) ratio of 36. In the past 30 years, that ratio has typically been between 15 and 25.
Since 2014, Alphabet's market capitalization as a multiple of sales and cash flow has stayed in a fairly well-defined range. That's likely due to its size and consistent growth. If financial performance is predictable, any changes in valuation tend to reflect market sentiment overall. Right now, sentiment is clearly negative. Excluding the brief collapse at the beginning of the pandemic, the stock trades near the bottom of both ranges.
GOOGL Price to CFO Per Share (TTM) data by YCharts.
Of course, revenue and cash flow could drop if there is a recession. But based on the recent past, the current price is a good one. Besides, the company performed well during the last two recessions. Revenue was essentially flat in the second quarter of 2020, and it actually grew from 2008 to 2009.
A shifting capital allocation strategy
One of the reasons Wall Street loves a predictable, highly profitable business is because eventually much of that cash comes back to shareholders. Alphabet has been sending clear signals for a few years that it recognized this. And it is upping the amount.
In April, management announced a $70 billion stock-buyback program. That came after a $50 billion authorization in 2021 and a $25 billion authorization in 2019. Last year, it repurchased more stock than any other public company except Apple. It's welcome news for investors and another reason to hold shares despite the economic uncertainty.
GOOGL Shares Outstanding data by YCharts
Adding it all up
The stock market can be scary at times. That's why it's important to dedicate some of your portfolio to high-quality companies. They may not be as exciting. But it reduces volatility and quiets the internal voice that says to sell when the markets slide.
An old stock market adage is "No one rings a bell at the top." Unfortunately, they don't ring it at the bottom either. Successful investors take advantage of opportunities when they are presented even if there might be more pain ahead. Google's strength looks intact for at least the next few years. It's why I'll be adding it to my portfolio as soon as trading rules allow.
