Google looks cheap at 27x earnings, but a DCF analysis suggests it is overvalued

stockoscope · 2026-07-07T08:23:32+00:00

=== SUMMARY === - The author applies a DCF model to Alphabet (GOOGL) that assumes currently elevated AI capex will eventually decline to maintenance levels, finding the stock ~30% overvalued at current prices despite a 27x P/E. - The core thesis is that massive capex (doubling to $175-190B in FY2026) is consuming nearly all incremental operating cash flow, preventing free cash flow growth and thus reducing intrinsic value. - Quality assessment: Well-researched DD with transparent methodology and cross-referenced with other DCF estimates, but relies heavily on the assumption that capex is temporary and does not convert into revenue growth. === SENTIMENT === BEARISH === TRADE IDEAS === GOOGL - AVOID | confidence: 0.65 | sentiment: -0.40 Speaker: u/stockoscope Thesis: 1. THE FACT: Alphabet’s capex/revenue jumped from 15% to 23% in FY2025, guided to double again to ~37% in FY2026, while free cash flow stagnated at $73B. 2. THE BRIDGE: If AI spending does not convert into proportional revenue growth, the stock lacks margin of safety and DCF fair value ($252) is 30% below current price (~$360). 3. THE VERDICT: Extraordinary business, but not a wonderful buy at a fair price — the negative margin of safety suggests avoiding new long positions until either price falls or FCF growth materializes. 4. RISKS: AI capex could be self-funding: Google Cloud revenue and margins accelerating would validate the spend and make the DCF assumption wrong. Also, Berkshire’s large position signals long-term confidence. Timeframe: medium-term Key Points: - Capex surge consumes all OCF growth, FCF flat - DCF models show 30%+ overvaluation vs price - Author explicitly says not a short, but not a buy === COMMENTS SUMMARY === Top comments challenge the author’s “holding everything else constant” assumption: u/Aya_Research argues that doubling capex without modeling higher revenue growth bakes in a bear case, and the real test is Google Cloud revenue/margin trends; u/sandhutarun notes Google’s

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The author applies a DCF model to Alphabet (GOOGL) that assumes currently elevated AI capex will eventually decline to maintenance levels, finding the stock ~30% overvalued at current prices despite a 27x P/E.
The core thesis is that massive capex (doubling to $175-190B in FY2026) is consuming nearly all incremental operating cash flow, preventing free cash flow growth and thus reducing intrinsic value.
Quality assessment: Well-researched DD with transparent methodology and cross-referenced with other DCF estimates, but relies heavily on the assumption that capex is temporary and does not convert into revenue growth.

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Last year I posted a breakdown in this sub arguing Microsoft was overvalued at $490 because of its [capex spend](https://www.reddit.com/r/ValueInvesting/comments/1p9ks0t/understanding_michael_burrys_nvidia_short_the/). But that thesis was never really about Microsoft - it applies to every hyperscaler pouring money into AI. Last week I updated my [MSFT valuation ](https://www.reddit.com/r/ValueInvesting/comments/1uio0by/six_months_ago_we_called_microsoft_overvalued_at/)and applied the same model to [Meta](https://www.reddit.com/r/ValueInvesting/comments/1umbmng/the_meta_version_of_my_microsoft_capex_breakdown/). Today, I'm pointing it at Alphabet. Please read the previous posts for details about the methodology.

**Capex and cash flow**  
  
In FY2025, Alphabet's operating cash flow jumped from $125B to $165B in a single year, but free cash flow barely moved. The entire difference, roughly $39B of extra operating cash, went into capex, which nearly doubled from $52B to $91B in one year and climbed from 15% to 23% of revenue.   
  
So Alphabet is generating far more cash than ever and keeping almost none of it. And the speed is accelerating. Alphabet has guided 2026 capex to roughly $175-190B, more than double the 2025 figure. This impacts DCF valuation.

|Fiscal year|Capex / revenue|Operating cash flow|Free cash flow|
|:-|:-|:-|:-|
|FY2020|12.2%|$65.1B|$42.8B|
|FY2021|9.6%|$91.7B|$67.0B|
|FY2022|11.1%|$91.5B|$60.0B|
|FY2023|10.5%|$101.7B|$69.5B|
|FY2024|15.0%|$125.3B|$72.8B|
|FY2025|22.7%|$164.7B|$73.3B|

**DCF Valuation**

Our DCF approach glides capex from today's elevated rate down toward maintenance over the forecast, and uses maintenance in the terminal value. It assumes the AI surge is temporary on the logic that no company can spend 20% plus of revenue on capex forever.

Here are teh valuations, changing only the capex assumption, holding everything else constant:

|What you assume long-run capex does|Fair value|vs Price|
|:-|:-|:-|
|Glides down to maintenance (our default)|$252|\-30%|
|Glides from the FY2026 pace (\~37%) down to maintenance|$213|\-41%|
|Stays permanently elevated at \~18% of revenue|$160|\-55%|
|Glides from the FY2026 pace down to that elevated \~18%|$126|\-65%|

Unlike MSFT and META, every single row in the table is below the current price. Even the most generous case, assuming that the buildout fully normalizes, leaves GOOGL about 30% overvalued. (We added a switch to the valuation page so you can toggle the assumption yourself and watch fair value move).  
  
Because a contrarian DCF is easy to dismiss, I dug up other publicly available DCF estimates to see how ours compares:

|Source|DCF fair value|vs price|
|:-|:-|:-|
|Stockoscope|$252|\-30%|
|MiniValuator|$259|\-28%|
|Alpha Spread|$308|\-14%|
|Simply Wall St|$361|fair-valued|

All of them land at or below the price. Although I am not sure how they handle capex, none of them calls Alphabet a bargain on cash flow. 

**So where does that leave it**  
No doubt Alphabet is an extraordinary business. I'm also aware that Berkshire bought a lot of it (and I have huge respect for them), but I can't call this a wonderful business at a fair price, even if I want to. Google looks cheap on the surface, trading at about 27 times earnings. Yet on our DCF, it screens roughly 30% overvalued. And it's not just our model -  every DCF-based estimate I could find lands at or below the current price.

However, that does not make it a short, and it does not mean the stock cannot keep rising. Great businesses trade above intrinsic value for years. It means the margin of safety is negative right now, and the thing that would change that is either a lower price or evidence that the AI spending is converting into free cash flow.

That completes the three-part series on the impact of capex on hyperscalers. Thanks for engaging with it and for all the feedback. One thing I haven't done yet is evaluate what all this means for NVDA (that's where this all started) - which is what I plan to tackle next.

Disclaimer: This is for educational purposes only and is not investment advice. The author and Stockoscope may hold positions in the securities mentioned. Always do your own research.

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