Alphabet and Amazon Are Cheaper Than the S&P 500. What's Going On?

Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) and Amazon (NASDAQ: AMZN) look cheaper than the S&P 500 (SNPINDEX: ^GSPC) at face value. Right now, Alphabet and Amazon trade for 17 and 20.9 times earnings, respectively. The S&P 500 (SNPINDEX: ^GSPC) trades for 24.2 times earnings, making these two far cheaper than the broader market.

Considering that Alphabet and Amazon are two of the most popular big tech stocks available and both are growing at an incredible pace, this difference seems odd. So, what gives? Are these two actually screaming values begging to be bought, or is there something else going on here? Let's take a look.

Image source: Getty Images.

Alphabet and Amazon each have one-time effects skewing their earnings

The price-to-earnings (P/E) ratio is the most popular tool investors use to value stocks, but it is far from perfect. Earnings per share (EPS) can be skewed in a variety of ways, and some of them are completely out of the company's control. One way this happens is thanks to gains on investments.

Both Alphabet and Amazon have extensive investment portfolios, and each has seen their holdings dramatically rise in value this year. Both Amazon and Alphabet are major investors in Anthropic, the AI firm whose flagship model is Claude. Anthropic is expected to go public in the near future, with reports circling that it's targeting a $2 trillion valuation. However, Amazon and Alphabet's reported gains are based on Anthropic's latest funding round, which saw the firm valued at $965 billion at the end of May.

Even though neither Amazon nor Alphabet sold their stake in Anthropic, generally accepted accounting practices (GAAP) require them to report the gain as an increase in earnings. This causes the EPS metric to rise without them selling, thus skewing Amazon and Alphabet's P/E ratio.

Alphabet also had another investment produce a huge gain, as Space Exploration Technologies, better known as SpaceX, generated a massive gain for Alphabet during its second quarter. In fact, Alphabet produced $98 billion in "other income" during Q2, mostly from the gains it has on paper from Anthropic and SpaceX's rise.

This explains why Alphabet and Amazon look so cheap, but are they actually cheap?

Amazon and Alphabet are still solid deals.

There are a handful of ways to value these stocks that don't include the one-off effects from gains on investments. One way is to look at earnings projections for the next fiscal year. These projections don't include any gains on investments, because those are impossible to forecast. Instead, they just utilize where analysts think the company's primary businesses will go, and both Amazon and Alphabet are still valued at reasonable levels from this perspective.

GOOG PE Ratio (Forward 1y) data by YCharts

With Amazon trading at 25 times next year's earnings and Alphabet at 23 times next year's earnings, the premium investors have to pay for these two stocks is familiar. But these prices are still fairly reasonable to pay considering the leading role these two play in the AI arms race. Both of these companies are major cloud computing providers and are spending hundreds of billions of dollars to build out computing capacity for AI firms to utilize. This is leading to massive growth rates for both companies, and each is growing at its fastest pace in years as a result.

GOOG Revenue (Quarterly YoY Growth) data by YCharts

Both Amazon and Alphabet are long-term beneficiaries of this trend, and I think they will be incredible investments over the next decade. With each stock still trading at a reasonable valuation, yet their growth rates accelerating due to huge growth, now is the perfect time to buy.

Keithen Drury has positions in Alphabet and Amazon. The Motley Fool has positions in and recommends Alphabet and Amazon. The Motley Fool has a disclosure policy.