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Do Dividends Really Make Alphabet Stock More Attractive?

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The US market reacted positively this week to the news that Google and Youtube owner the alphabet (NASDAQ: GOOG ) (NASDAQ: GOOGL ) plans to finally start paying a dividend. This suggests that investors view this move as positive. But does that really make Alphabet stock more attractive – or could it suggest the end of the company’s golden growth years?

More cash than great growth ideas?

When a company generates a lot of spare cash, it can invest it in continued growth, spend it on dividends, sit on it for a rainy day — or a combination of these.

Alphabet is a huge cash generator. It has invested heavily in the development of new products and services, but has still been accumulating cash over the years. He concluded his most recent quarter. $111bn in cash, cash equivalents, and marketable securities.

In the most recent quarter alone, the company had free cash flow of $17bn.

With its huge customer base, service ecosystem and low marginal cost of adding more customers, Alphabet is a free cash flow machine.

Source: TradingView

The initial quarterly dividend, 20c per share, is modest. This represents an annual dividend yield of less than 1%.

But could this suggest that the company now lacks enough business growth ideas to spend all its extra cash on?

Fine-tuning a proven business model

I think it could be. But that’s not necessarily bad for Alphabet stocks. The company generates enough cash to easily pay dividends and continues to invest heavily in growth.

In the latest quarter, revenues rose 15 percent compared to the same period last year. Alphabet has an impressive track record of revenue growth. I see no reason that couldn’t continue, even once it started spending money on profits.

Source: TradingView

In that sense, I don’t think the dividend fundamentally changes the case for Alphabet investing. Arguably, this makes it more attractive, as not only will the share now attract income investors, but the move also shows that management is thinking about shareholders’ interests.

Long-term momentum change

Then look again apple (NASDAQ: AAPL). It brought back its profits in 2012 after not making a single payment for several years. Since then, profits have steadily increased. But, last year, both revenue and earnings at the tech giant were weak compared to the previous year.

Still, Apple stock is up 4% over the past year and 232% over the past five years.

That’s a markedly better performance than the (very impressive) 148% gain recorded by Alphabet stock over the past five years (this chart shows Apple in blue and Alphabet in orange).

Although earnings fell last year, Apple’s use of some of its excess cash to buy back shares meant its underlying earnings per share continued (just) to rise.

Source: TradingView

Alphabet has major competitive advantages from its proprietary technology to a broad user base. It faces challenges, such as rivals leading it on AI, eating into both Alphabet’s revenue and profits.

Over time though, I expect it to continue to generate a lot of cash flow. Paying a dividend need not slow down its growth. I see this as either neutral or positive for the investment case.

That said, Alphabet stock’s price-to-earnings ratio is about 30 more than I’m comfortable with, so I have no plans to invest.

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