Wide-moats Alphabet (GOOG) and Facebook (FB), both trading in 4-star territory, became more attractive after declining 2% and 4%, respectively, on fears of rising rates, deceleration in digital ad spending growth in the second half of this year, and possibly rotation into cyclical names. Our fair value estimates for Alphabet and Facebook remain at US$2,925 and US$390, respectively; representing a 27% upside for both from May 10 closing prices.
In our view, the fears referenced above are disputable. While rising rates should pressure multiples, Alphabet and Facebook have already been trading at what we view as unwarranted discounts compared with their peers. In terms of a slowdown in ad revenue growth during the second half of 2021, that would be a short-term artifact of tougher comps resulting from the pandemic, and we have already accounted for that in our valuation model. We expect digital ad revenue growth will remain at strong double-digit rates for both firms for several years.
While the two firms also face fierce pressure from all sides of the political spectrum to limit data usage and further prioritize data privacy, we believe advertisers will continue to allocate a higher percentage of their ad budgets toward Google and Facebook due to both platforms’ very large user bases. We remain confident that both firms will benefit significantly from the economic recovery as ad spending picks up. For this reason, while indirectly, the two still can be viewed as recovery plays.
Both stocks face additional risks such as impact from a possible increase in the federal statutory tax rate, along with higher rates on global intangible low-taxed income, and possibly the elimination of the foreign-derived intangible income deduction. We think these items could pressure our fair value estimates for Alphabet and Facebook by 8%-11% and 6%-10%, respectively. Assuming such an impact, the upsides based on current trading levels are still above 15% for both.
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