Alphabet Is Facing Thousands of Lawsuits. History Says This Is What May Happen

Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) has outperformed the broader market over the past year, but recent developments have halted the company's run. Alphabet's second-quarter results, released on July 22, spooked investors, as its free cash flow turned negative due to significant investments in artificial intelligence (AI). Further, Alphabet is facing legal troubles. There are thousands of lawsuits alleging that the company's social media platform, YouTube, causes addictive behavior and harms users, especially younger users (these lawsuits also target other social media leaders).

A federal judge recently ruled that these lawsuits can move forward. So, this may be the beginning of a drawn-out legal battle for Alphabet. Should investors avoid the stock due to these developments? Perhaps considering some major legal battles that large corporations have endured in the past will tell us something about the impact the ones Alphabet is facing could have on its business.

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Big corporations tend to overcome the challenge

The legal process is slow. Lawsuits against major corporations can take years, sometimes even decades. Companies with large client bases and significant earnings and cash flows can absorb these costs in various ways. They may insure themselves against significant legal troubles while gradually recognizing expenses and losses. Even a massive, multibillion-dollar settlement spread out over multiple years may not be too damaging to a well-established, financially sound company.

Further, businesses can even pass some of those legal costs on to customers by raising prices slightly. In other words, companies can navigate significant legal challenges when they are financially strong and flexible enough, and still generate strong results while facing lawsuits. That's why even massive legal battles haven't led to catastrophic consequences for many major corporations. Let's take one famous example. Consider the dozens of lawsuits tobacco companies faced in the 90s.

This led to a massive 1998 settlement, called the Master Settlement Agreement (MSA), involving 46 U.S. states and several territories that agreed to settle the lawsuits against major tobacco companies in exchange for billions in ongoing payments and restrictions on advertisement. The major tobacco companies involved in these lawsuits survived the ordeal. For instance, Philip Morris International and Altria Group are descendants of the former Philip Morris, which signed the MSA.

There are other examples, including in the antitrust landscape, where Microsoft and, more recently, Alphabet itself escaped catastrophic consequences for their alleged antitrust practices. So, the historical record suggests that, even if Alphabet won't emerge from these legal battles entirely unscathed, the company should still come out in one piece.

Alphabet's prospects still look bright

Of course, the past isn't a guarantee. Alphabet may succumb to these lawsuits. However, the tech leader is much larger and generates significantly more earnings and cash flow than most businesses ever created. If I were to pick any company that can withstand an avalanche of lawsuits, Alphabet would be among my top five picks. This doesn't mean investors should ignore this risk. It will likely reduce Alphabet's earnings and cash flows relative to what they would have been without the litany of lawsuits.

That means the company's intrinsic value is lower than it otherwise would have been, and it may still be worth investing in, but at a lower price. Even with those caveats, Alphabet looks like a steal at current levels. The company is trading at 17.4x forward earnings, versus an average of 17.7x for communication services stocks. That's even though Alphabet is a leader across several categories: Internet search, streaming, and cloud computing, all of which arguably have massive growth runways.

Alphabet is generating excellent financial results, and the company's cloud computing business in particular is growing much faster than the others. Even with massive capex to fund its AI ambitions, the tech giant could more than justify the spending, given that AI has already significantly improved its business. Further, Alphabet has a wide moat from multiple sources, including network effects and a solid brand name in internet search and streaming. The bottom line: Alphabet is unlikely to suffer catastrophic losses from the lawsuits it faces, and the stock should still deliver solid returns over the long run.

Prosper Junior Bakiny has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet and Microsoft. The Motley Fool recommends Philip Morris International. The Motley Fool has a disclosure policy.