Bill Ackman, hedge fund manager, advocates owning a small group of stocks. He’s willing to ride these best ideas for years. One of those best ideas is Alphabet (NASDAQ:GOOG). Pershing Square Capital Management owns 9.38 million Class C and 4.35 million Class A shares. Together, Pershing has nearly $2 billion in Alphabet stock.
Ackman’s stake in Google’s parent company accounts for more than 18.5% of his firm’s $10.4 billion in assets reported in its Q4 2023 13-F. With the two share classes combined, Alphabet is Pershing’s second-highest holding by percentage, surpassed only by Restaurant Brands International (NYSE:QSR) at just less than 19%.
Except for Lowe’s Companies (NYSE:LOW), each of Pershing’s seven holdings has a weighting of at least 11%.
You could argue that Alphabet stock should be the hedge fund’s largest position. Here’s why.
Free Cash Flow and Alphabet Stock
Through Q1 2024, Alphabet’s trailing 12-month free cash flow was $69.11 billion, 21.7% of its $318.15 billion in revenue. Adding up the trailing 12-month free cash flow of Pershing’s other six holdings, it comes to $11.88 billion, or about one-sixth Alphabet’s.
Based on the other six’s combined revenue of $129.08 billion, the average margin is 9.2%, less than half of Alphabet’s.
Free Cash Flow Margins — Pershing Square Capital Management Holdings
All the other holdings possess healthy free cash flow, except for Howard Hughes, a real estate developer who doesn’t focus on this financial metric. You can’t go out of business if you bring in more cash than you send out.
In the fourth quarter of 2023, Pershing cut its Lowe’s holdings by 82%. Ackman likely left some money on the table as LOW stock hit a 52-week high of $262.49 in March. I would not be surprised if Pershing sold out of its Lowe’s position in the first quarter, given it paid an average of $100.43 a share.
If you take out Lowe’s numbers, the free cash flow margin for the other five stocks jumps to 13.3% [free cash flow of $5.70 billion divided by $42.70 billion], 840 basis points less than Alphabet.
There is no question that Alphabet is the best free cash flow generator.
How Does It Compare to the Other Magnificent 7 Stocks?
There are 64 analysts covering GOOG/GOOGL stock, with 50 rating it a Buy with a $195 target price, 14% higher than where it currently trades. So, that’s 78% of analysts rating it a Buy.
At least from the perspective of analysts, Alphabet is not the favorite Mag 7 stock.
I won’t review all the free cash flow margins for the other six Mag 7 stocks. However, Amazon, which has the highest Buy percentage at 97%, has a free cash flow margin of 7.7% based on $45.70 billion in TTM free cash flow and $590.74 billion in revenue.
In fairness to Amazon, if you exclude its e-commerce revenue, the free cash flow generation is much stronger. With all it has going with its ad business and AI, its free cash in about five years will be considerably more impressive. It’s not hard to see why so many analysts rate it a buy.
Next up is Microsoft, which has a 95% Buy percentage. It’s more of an apples-to-apples comparison. Its free cash flow margin is 29.8% based on $70.58 billion in TTM free cash flow and $236.58 billion in revenue.
Satya Nadella is one of the best CEOs in America. Since taking the helm on Feb. 4, 2014, MSFT stock is up 1020%, 544 percentage points higher than Alphabet over the same period.
MSFT is the class of the Mag 7.
The Bottom Line on GOOG Stock
Last December, I wrote about how Alphabet was spending money in all the wrong places. Notably, it had repurchased more than $100 billion of its stock over the previous two years. And while its underperforming shares made some buybacks worthwhile, it should have invested at least 50% of these funds in its business.
The company’s employees are fed up with shareholders getting all the benefits of its strong free cash flow.
“Despite the company’s stellar performance and record earnings, many Googlers have not received meaningful compensation increases,” Fortune reportedCNBC comments made by an employee after the company’s blowout quarter. “When will employee compensation fairly reflect the company’s success and is there a conscious decision to keep wages lower due to a cooling employment market?”
If you can only buy one Mag 7 stock, Microsoft is the call. However, Alphabet’s free cash flow always keeps it in the mix.
Alphabet is a Moderate Buy.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.
