The FAANG acronym is short for Facebook (now Meta Platforms), Apple, Amazon, Netflix, and Google -- a stand-in for its parent, Alphabet (GOOG 0.23%) (GOOGL 0.23%).
While there are certainly some other companies investors could include in there -- like Microsoft, Nvidia, or even Tesla -- the abbreviation is generally intended to be a catchy tracker for the performance of America's largest technology companies. And so far, this cohort of tech juggernauts is driving the Nasdaq Composite Index to a record-setting start to the year.
QQQ total return level data by YCharts.
But even with the recent climb in prices, there is one FAANG stock that still looks undervalued, and that's Alphabet.
A toll road on the internet
Despite the recent buzz caused by the popular AI chatbot ChatGPT, Alphabet's Google has retained its remarkable dominance within digital search with roughly 93% market share across mobile, desktop, and tablet. In fact, since the launch of ChatGPT in November of 2022, several estimates show that Google's share of search has actually grown.
As a preeminent landing page for internet users globally, Google is able to monetize its crucial role through advertisements. It does this in a number of ways, but the two most popular are search ads and display ads.
Between these two options, companies looking to promote a product or service can either bid to have their promotion show up under popular search terms or run a visual advertisement across other websites and pay when someone clicks on it.
Thanks to Google's ability to track user activity, it can more accurately determine the effectiveness of marketing campaigns for businesses. That has proved to be quite a compelling proposition for any company trying to closely monitor its marketing budget.
This toll road model of generating revenue whenever users cross one of Alphabet's properties is quite the cash generator for the company. Over the last five years, it has generated more than $700 billion in revenue from search and display ads, which is far more than any other company in the world.
Don't forget YouTube
While Alphabet's search division deservedly catches most investors' attention, it has several other businesses under its umbrella that not only drive additional revenue, but in most cases also enhance the value of its overall ecosystem.
These include business units like Google Workspace, Google Maps, Google Cloud Platform, Android, Waymo, and plenty of others. But perhaps the most impressive subsidiary within the entire Alphabet complex is the video-sharing behemoth YouTube.
It is the largest video-sharing platform globally, and it makes money in a number of ways. For starters, it currently generates $29 billion a year in revenue purely from advertising, which is up more than 250% from five years ago.
And that figure doesn't encapsulate nearly all of its revenue. In 2018, the platform began offering an ad-free subscription tier called YouTube Premium, which the company includes in its $30 billion Google Other revenue line.
While it's difficult to know how much of that revenue comes from YouTube Premium, investors got a glimpse of the size of the business during Alphabet's recent fourth-quarter conference call when CEO Sunder Pichai announced that Premium had surpassed more than 80 million subscribers, inclusive of free trials.
Assuming average revenue per subscriber of $10 a month (the current plan is $12 monthly in the U.S., but it's cheaper internationally), that would mean YouTube Premium generates about $10 billion a year on its own.
While the financials are certainly impressive, it's the competitive advantages that I think investors should be the most excited about. YouTube has a tremendous network effect. This means that since it is home to an estimated 2.7 billion monthly active users, it's the premier destination for creators to distribute content.
On the flip side, as more people create content for YouTube, the more attractive the platform is for viewers. For investors, this should also mean increasing profitability as the platform continues to grow since there is such little cost to attract new users.
Buying Alphabet for the long haul
Alphabet's stock is already up almost 40% year to date, so it raises the question: Why buy now? Well, despite the recent run-up, Alphabet's current ratio of enterprise value to free cash flow is only roughly 23. That's below its average valuation over the last 10 years and the cheapest among all the other FAANG stocks.
Though a cheap valuation shouldn't be the only reason to invest in a stock, Alphabet's various operating segments have competitive advantages and look well positioned to continue driving revenue for years to come.
