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What's the Better Value for Investors: Amazon or Alphabet?

Better value doesn’t necessarily mean better stock.

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Amazon.com, Inc. (AMZN) is beating Alphabet Inc (GOOGL, GOOG) when it comes to stock performance, up 14.1% year-to-date compared to 2.7% for Google’s parent.

The same story plays out over one-year, three-year, five-year and 10-year periods (through September 13). AMZN stock’s always been the better play. However, as they say in the mutual fund business, past performance doesn’t guarantee future results.

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If ever there was a time for reversion to the mean to rear its ugly little head it would seem perfectly reasonable to assume that the Amazon/Google performance disparity that’s been demonstrated over the past decade would make for the ideal flip flop.

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So GOOGL Stock Wins?

From a value perspective it seems logical that if Google’s stock’s been pummeled by Amazon for more than a decade, that GOOGL should be the better buy — shouldn’t it?

Well, not exactly.

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First, one has to consider how they define “value.” Is it price-to-earnings, sales, cash flow, buttons, or some other valuation exercise that speaks to the analytical side of your brain?

Is value the price paid today or the price received tomorrow? It’s all in the eye of the beholder.

Let’s take a quick look at each company’s current valuation.

The Valuation Case — P/E

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Google’s trailing-12-month P/E ratio (TTM) is 30.6 and its forward P/E ratio is 19.6. Meanwhile, Amazon’s TTM P/E ratio is 189.3 and its forward P/E ratio is a more palatable 49.3, almost three times greater.

From this single view, GOOGL stock is absolutely a better value than AMZN. After all, would you pay $50 for a steak at one restaurant when you can get exactly the same quality product at another restaurant that costs $30 less? I don’t think so.

The problem with using earnings is they can sometimes provide unreliable comparisons because of timing issues such as different quarter-ends, etc. A much less problematic way to examine the value proposition is through sales. Sure, quarters not aligning can still be a problem but not nearly as much.

In Google’s case, its stock trades at 6.7 times sales or about twice AMZN’s multiple of 3. From this perspective, at least, AMZN is the better value.

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More importantly, research by portfolio manager James O’Shaughnessy has shown that the P/S ratio is the best metric to demonstrate value.

Under O’Shaugnessy’s method, neither Amazon or Google would be considered value stocks — his cutoff point was 1.5 or less. In addition, O’Shaughnessy liked to see five years of consecutive growth in earnings per share. That eliminates Amazon, whose earnings in recent years have been almost purposefully erratic.

Fortunately, the question here isn’t whether Amazon or Google are value stocks, but rather which is the better value.

The Value Case — FROIC

Free cash flow return on invested capital, or FROIC, is the least known of the three valuation metrics I’m choosing to use for this particular stock showdown. But, it’s quite possibly the best one going because it tells us how much free cash a company is generating from its invested capital.

There are a couple of steps involved.

First, we need to calculate both Amazon and Google’s free cash flow in total dollars and on a per share basis. Then, we must calculate their total capital which is long-term debt plus shareholder equity. Once we’ve got that answer, we divide free cash flow by total capital and the answer we get tells us how good each company is at deploying capital.

Amazon’s free cash flow for the trailing 12 months according to Morningstar was $7.33 billion. With 481 million shares outstanding, its free cash flow per share is $15.24 for a P/FCF ratio of 49.9.

Google’s free cash flow for the trailing 12 months according to Morningstar was $20 billion. With 697 million shares outstanding, its free cash flow per share is $28.69 for a P/FCF ratio of 27.5.

Google strikes the first blow.

As of the second quarter, 2016, Amazon’s long-term debt was $8.2 billion; its shareholder equity $16.5 billion for total capital of $24.7 billion. That means AMZN generates 33 cents from every dollar of capital employed.

As of Q2 2016, Google’s long-term debt was $2 billion; its shareholder equity $120.3 billion for total capital of $122.3 billion. That means Google generates 16 cents from every dollar of capital employed.

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Amazon strikes the second blow.

The Better Value?

This is a tough one.

While Amazon exhibits better deployment of capital and is cheaper on a price-to-sales basis than Google, it’s hard to overlook the fact Amazon’s P/E and P/FCF ratios are considerably higher.

In the end, Google might be the better value but Amazon is the better stock.

This article is from Dan Burrows of InvestorPlace. As of this writing, he did not hold a position in any of the aforementioned securities.

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