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The US market reacted positively this week to the news that Google and Youtube owner Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) finally plans to start paying dividends. It suggests investors view the move as positive. But does this really make Alphabet stock more attractive, or could it signal the end of the company's golden years of growth?
More effective than big growth ideas?
When a company generates a lot of extra cash, it can invest it in continued growth, spend it on dividends, wait out a difficult time, or a combination of both.
Alphabet generates enormous cash. It has invested heavily in developing new products and services, but has still been hoarding cash for years. It ended its most recent quarter with 111 billion dollars in cash, cash equivalents and marketable securities.
In the last quarter alone, the company had free cash flows of $17 billion.
With its huge customer base, ecosystem of services, and low marginal costs to add more customers, Alphabet is a free cash flow machine.
Source: TradingView
The initial quarterly dividend, 20 cents per share, is modest. That represents an annual dividend yield much less than 1%.
But might it suggest that the company now lacks compelling enough business growth ideas on which to spend all its spare money?
Fine-tune a proven business model
I think I could. But that's not necessarily bad for Alphabet stock. The company generates so much cash that it can easily pay a dividend and also continue to invest substantially in growth.
In the latest quarter, revenue grew 15% compared to the same period last year. Alphabet has an excellent track record of revenue growth. I see no reason why this can't continue, even once you start spending money on dividends.
Source: TradingView
In that sense, I don't think a dividend will fundamentally change Alphabet's investment case. Arguably making it more attractive, as not only will the stock now attract wealthy investors, but the move also shows that management is thinking about shareholders' interests.
Long-term momentum changes
On the other hand, look Apple (NASDAQ:AAPL). It recovered its dividend in 2012 after many years without paying it. Since then, the dividend has increased steadily. But last year, both the tech giant's revenue and revenue were weaker than the year before.
Still, Apple shares are up 4% over the past year and 232% over the past five years.
This is 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 revenue fell last year, Apple used some of its excess cash to buy back shares, meaning its core earnings per share continued to (only) grow.
Source: TradingView
Alphabet has enormous competitive advantages, from its proprietary technology to a broad user base. It faces challenges, such as its competitors leading it in artificial intelligence, which reduces both Alphabet's revenue and profits.
However, I expect it to continue generating huge cash flows over time. Paying a dividend does not have to stop its growth. I see it as neutral or positive for the investment case.
That said, Alphabet stock's P/E ratio of around 30 is higher than I'm comfortable with, so I have no plans to invest.