Seth Klarman is a well-respected value investor with a global following. And there's good reason for that. His Baupost Group hedge fund returned an average of 20% per year over the first 30 years of its existence. That performance comes despite value stocks falling well out of favor over the last decade.
But Klarman and his team emphasize that they "remain flexible in their application" of value investing. That means investing in stocks that are mispriced relative to their value, even if they won't show up on any stock screeners for deep value based on traditional metrics. As a result, this method can end up with some stocks that many investors would consider growth stocks, such as those found in the Magnificent Seven.
But Klarman only sees one member of the vaunted group of trillion-dollar stocks as worth his and his investors' money, and he just added more of it to Baupost's portfolio.
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The only Magnificent Seven stock Klarman likes
The Magnificent Seven is a group of stocks full of interesting opportunities for the right investor. And anyone who invested in any or all of them is probably happy with their returns over the last couple of years. But a few may not present the value necessary for an investment from someone like Klarman. As a group, they're relatively expensive based on traditional valuation standards.
Four of the seven sport forward P/E ratios above 30, including Tesla (TSLA +2.96%) with its 168 times multiple. While Tesla could prove worth the price with its plans for a robotaxi service and humanoid robots, there's a lot of risk in buying the stock at its current price, especially as its core car business is facing stiff competition abroad. The other high-priced members are growing quickly and on relatively solid footing, but it's hard to argue they're a bargain at their current prices.
But one member of the group trades for a valuation below the S&P 500's average, and that's kind of surprising for a stock with such strong growth potential. The stock has consistently traded at or near the lowest valuation of the Magnificent Seven, giving investors plenty of opportunities. That's why Klarman and his team have built up a position in Alphabet (GOOG +1.99%) (GOOGL +1.71%), including adding 652,000 more shares in the first quarter, increasing its stake in the company by 46%.
The best value among the Magnificent Seven
There are good reasons for Alphabet to trade at a lower valuation than the rest of the group. It carries some significant risks.
The first big risk facing Alphabet is regulatory risk. The company faces several lawsuits in the U.S. and elsewhere that could result in interventions to reduce any monopolistic powers, particularly in web search and digital advertising. That could include things like selling its Chrome browser or its ad marketplace and ending agreements like its $20 billion per year traffic acquisition partnership with Apple.
Despite those risks, the impact on Alphabet's operations could be muted given the strength of its brand and product. That's where the second risk comes in. Many see artificial intelligence (AI) chatbots like OpenAI's ChatGPT eating into Google's dominance of web search. In a hearing last month, Apple's Senior VP for Services, Eddy Cue, suggested iPhone users are searching less in 2025 and spending more time in AI apps.
However, the data from Alphabet doesn't support the narrative that it's losing significant share to AI. In fact, AI may be a boon to its search business thanks to three new features the company's introduced to leverage the power of large language models. Its AI Overviews (and now AI Mode) have led to increased user engagement and satisfaction, as users expand the search queries they send to Google. Importantly, management says it's able to monetize searches with AI Overviews at the same rate as searches without it. Two other AI-powered features driving search are circle-to-search and Google Lens, which have increased valuable product searches on Google.
NASDAQ: GOOG
Key Data Points
One piece of Alphabet's business that has seen very strong results without much regulatory threat is its Google Cloud platform. The cloud computing segment is seeing strong demand fueled by AI, which pushed its revenue 28% higher year over year in the first quarter. Moreover, its operating margin expanded to 17.8% from just 9.4% last year, and there's still significant upside from there.
Alphabet is also home to "Other Bets," which includes the leading self-driving car company, Waymo. Waymo's made significant progress in its robotaxi business and remains years ahead of the next closest competitor. It now completes 250,000 paid trips per week, as of its most recent update at the start of May. As the market expands, Waymo could prove a significant growth driver for the company.
All this is to say, the company as a whole should conservatively be able to produce double-digit revenue growth for the foreseeable future despite the regulatory and competitive challenges it faces. And as Google Cloud and Waymo scale, they should enable even faster earnings growth. At a forward P/E close to 18, Alphabet's stock looks like a bargain among the Magnificent Seven. It's no wonder Klarman and his team have continued to add shares around this price.
