Key Points
Amazon and Alphabet are the cheapest stocks in the "Magnificent Seven" based on their respective earnings.
Their growth rates have been comparable in recent years, although Alphabet has had a slight edge of late.
Amazon's business is larger, but Alphabet's is more efficient and profitable.
Amazon (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL) are two of the most valuable companies in the world.
Alphabet has a robust business centered around YouTube and Google, and its valuation is around $4.1 trillion, with Apple and Nvidia being the only other "Magnificent Seven" stocks to command a higher market cap. Amazon, whose online marketplace has become the go-to shopping option for many consumers around the world, has a more modest valuation of $2.8 trillion.
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Both of these tech stocks have made investors rich over the years. Today, they're the cheapest stocks within the Magnificent Seven. Which one should investors buy?
Image source: Getty Images.
Which business is growing faster?
Both Amazon and Alphabet have tremendous growth opportunities due to artificial intelligence (AI). And while they have both generally been moving in the same direction, Alphabet has had a slightly better growth rate in recent years.
AMZN Revenue (Quarterly YoY Growth) data by YCharts
Amazon, however, has a much larger business, as it has generated $776 billion in revenue over the past four quarters, versus $446 billion for Alphabet. While both tech companies are behemoths, Amazon's is significantly larger in terms of revenue, which can make it more challenging for it to continue to grow at a high rate.
Alphabet's business isn't as big, but it generates better margins
What I like about Alphabet's business is how efficient and highly profitable it is. Unlike Amazon, which is knee-deep in competition with Walmart and online retailers trying to undercut its marketplace, Alphabet is working from a much more dominant position. There aren't any serious rivals to YouTube or Google Search. While there are alternatives out there, they don't pose serious threats, as the company dominates search and the video-sharing market.
The company demonstrates its power when it adjusts its algorithms, which can make or break the traffic a video or a website gets from search results. Amazon simply doesn't have the same type of power that Alphabet does. And that's a big reason why Alphabet is able to secure stronger profit margins.
In the past four quarters, Alphabet has amassed $148 billion in operating profit, for an impressive margin of 33%. Amazon, by comparison, has averaged an operating margin of just 12% over the past 12 months.
Which stock is more reasonably valued?
An important consideration when picking a stock to buy is valuation. Even if a business is doing incredibly well, that doesn't mean that its stock is a buy at any price. A high valuation can make it difficult to earn a good return on an investment; even a stock whose underlying business looks incredibly strong may not be a good buy if its price tag is too high.
While there are multiple metrics investors can choose from when evaluating stocks, I prefer the forward price-to-earnings (P/E) multiple. This is based on analyst expectations and can be a better indicator of how expensive or cheap a stock is than the trailing P/E multiple, since it won't have one-time gains or losses and other nonrecurring items that can sometimes distort trailing earnings numbers.
At a forward P/E of nearly 24, Amazon's stock is a bit more expensive than the S&P 500 average, which is 19. Alphabet, meanwhile, trades at a slightly more modest forward P/E of just under 22.
Alphabet is the better buy, and it's not even close
Even though Alphabet has a higher market cap than Amazon, it still looks like the stock with more upside potential at this stage. While both of these companies can be big winners due to AI, Alphabet's business is more diversified and may be able to get a better return on its AI investments given its higher profit margins; it's the growth stock I'd go with today.
David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Nvidia, and Walmart. The Motley Fool has a disclosure policy.