Alphabet Inc (NASDAQ:GOOG) (NASDAQ:GOOGL) was the big winner in Q4 tech earnings season. In the same period when Meta Platforms (FB) was crashing on a slight miss and Netflix (NFLX) was crashing even harder on a beat, GOOG put out a release that beat significantly on the top and bottom lines. Investors were impressed, and rewarded GOOG with a small selloff instead of a large one. As of this writing, GOOG was down only 8.9% for the year - a massive vote of confidence from Mr. Market.
As a result of having sold off on high earnings growth, GOOG is today starting to show some "value" characteristics. The stock trades at just 24 times earnings, 7 times sales and 19 times cash flow, which is historically cheap. While GOOG has not fallen to FB-tier firesale levels, it is certainly cheap compared to itself in the past.
I don't mean to stretch this point too far. As a value investor, I don't find GOOG to be a rock-bottom bargain. The current valuation requires somewhat above-average growth to be justified. But I have nevertheless been accumulating the stock.
Why is that?
It has to do with Alphabet's competitive position.
Although GOOG trades at a significant premium to beaten down tech names like Meta Platforms and Alibaba (BABA), the premium is largely justified. GOOG is one of the few tech companies that owns not only websites and apps, but also the platforms on which they run. It is the owner of the Android operating system, the world's most popular mobile OS by installs and the second most valuable by app revenue, and it also designs hardware. While Alphabet is no Apple (AAPL) calibre hardware giant, its latest smartphone was a relative hit, breaking the previous sales record. So, this company has done a pretty good job of bundling hardware and software into an integrated ecosystem. Perhaps the best job of any company that's not called Apple.
In the recent Daily Journal (DJCO) investors' meeting, Charlie Munger mentioned Google and Apple as two notably "entrenched" tech companies. By that he meant that their position in the market was unassailable. In 2021, the world got to witness Apple single handedly take a bite out of Meta Platforms' revenue by hampering its data tracking. Early this year, Meta admitted that Apple's move will cost it $10 billion by year's end. Additionally, Meta cited TikTok, supply chains, and other factors as headwinds for its business. Alphabet is far less vulnerable to these risk factors. Alphabet controls its own mobile operating system, making it less vulnerable to Apple's moves. Additionally, its largest ad platform, Google.com, does not depend on data tracking anywhere near as much as social media platforms do, providing an additional layer of safety. For this reason, Alphabet can be thought of as a "fortress" company, deeply entrenched in the online advertising industry, with a relative lack of competitive threats.
A big part of my bullish thesis on Alphabet rests on its competitive position. The company has a set of durable competitive advantages that provide a basis for thinking it will grow over time. If a company has a dominant position in a growing market, it's reasonable to think that its earnings will grow over time. So, let's take a look at how Alphabet stacks up compared to the competition.
In online advertising, GOOG's main competitor is Meta Platforms. It has a 24% share of the market, second only to Alphabet itself.
In second place is Amazon (AMZN), with an 11.6% share.
Other noteworthy players are Microsoft (MSFT), through its LinkedIn subsidiary, and smaller social media players like Snap (SNAP) and Twitter (TWTR).
Alphabet's own share of the online advertising market is 28%, by far the largest of any company. In itself, this is not necessarily an advantage. A market dominant firm can lose its status by a competitor catching up with it. But in Alphabet's case, there are reasons to think its lead will be maintained.
The first of these is platform control. Alphabet owns not only websites and apps, but also browsers (Chrome) and operating systems (Android). This means that Alphabet's business is less vulnerable to other companies' actions compared to competitors. Apple can take revenue from Facebook by blocking tracking. It is less able to do that to Alphabet, which has its own mobile platform on which it sets policy. To be sure, Google apps were affected by Apple's app tracking transparency (ATT) changes just like FB's were. But Alphabet gets to decide whether and when Android pursues similar policies, which is a huge advantage. If Alphabet does bring in ATT for Android, it can give itself preferential treatment, like Apple did when it introduced the tracking changes on IOS.
Google's second big advantage is that its advertising platform doesn't depend on data tracking as much as some companies' do. On Google Search, Alphabet can simply show ads relevant to what the user searched for. This doesn't require any prior knowledge of the user to be effective. To be sure, Google does use retargeting and location data to make campaigns more effective. But Google's core ad functionality doesn't need a huge amount of data to show a relevant ad. If you search for "t shirts," Google can use just that one piece of information to show you ads for t shirts. There is no comparable way to "instantly target" on social media apps, which have fewer information-based queries and more personal ones.
My previous point about Google's comparative lack of dependence on data tracking requires further elaboration. This point refers mainly to ads on Google Search-not YouTube or the Play Store. Google Search has some unique qualities that allow instantaneous targeting with no prior knowledge of the user. Other ad businesses can't do this-at least not to the same extent.
To illustrate how this works, consider how you use Google.
If you're like most people, your process probably looks something like:
You hear about a topic (e.g. World War 2, laptops, shoes).
You want to learn more about it.
You visit Google and type in a query related to the topic you just heard about.
Let's say, for example, that somebody just told you about a new pair of sneakers from NIKE (NKE). If you liked Nike, you'd probably want to learn more. So, you'd go to Google and search for "new Nike shoes" or something similar. Nike would instantly be able to show you a relevant ad based just on this search. To test this out, I actually entered "new Nike shoes" into Google and looked at what showed up. This was the result:
As you can see, it's a text ad for Nike shoes. Google was able to show me that based on what I searched for. Prior to doing this experiment, I had never visited Nike's website, searched for Nike in Google, or done anything else on the internet to signal interest in Nike. Google was able to show me an ad that was relevant to what I was looking for anyway.
It's quite a different story with platforms like Facebook, Snap and Twitter. Some of these apps have search functions as well, but people mainly use them to search for people and groups, not things. Therefore, the information being entered in them can't be used to instantly target ads to the users' interests. So social media ads heavily rely on tracking user data for targeting. These apps don't get the same kind of non-stop stream of user intent that Google Search does.
Having looked at Alphabet's admirable competitive position, we can now turn the page to its financials. The company's most recent quarter was a huge beat, boasting metrics like:
Revenue: $75.3 billion, up 32% (beat by $3.5 billion).
Operating income: $21.9 billion, up 39%.
Net income: $20.6 billion, up 35%.
Diluted EPS: $30.69, up 36% (beat by $3.45).
It was a strong showing. Not only did all metrics exceed analyst estimates, but they did so at a time when many other tech companies were delivering lacklustre results. The profitability was particularly impressive. Based on the numbers above, we can calculate GOOG's operating margin at 29.3% and its net margin at 27.3%. Both very solid.
It's a similar story if we look at the long term averages. Alphabet's five year CAGR growth rates in headline financial metrics include:
Operating income: 27%.
Net income: 31.3%.
Diluted EPS: 32%.
So, GOOG's most recent quarter was no outlier. The performance was consistent with the company's long term growth track record. And now, with many of Alphabet's competitors getting hammered by Apple's ATT policy, there is reason to think it will scoop up more ad revenue in the future, keeping the historical growth trend intact.
And if that weren't enough, Alphabet also has one of the strongest balance sheets on the planet. At the end of the most recent quarter, it boasted:
$359 billion in assets.
$107 billion in liabilities.
$251 billion in shareholders' equity.
$14 billion in long term debt.
From these numbers it becomes clear that Alphabet is extremely financially sound. Assets vastly outstrip liabilities, and the long term debt to equity ratio is a mere 0.055! Yet despite Alphabet's strong growth and financial soundness, it trades for a mere 24 times earnings and 19 times operating cash flow. These aren't exactly bargain basement multiples, but they're relatively low for big tech. More importantly, they're lower than the multiples GOOG traded for in the past.
As we've seen, Alphabet is a company with a strong competitive position, high growth, and a healthy balance sheet. It definitely looks like a solid tech stock. However, there are some risks and challenges for investors to keep in mind. These include:
Political risk. Alphabet's services are vulnerable to getting banned in foreign countries for political reasons. Just recently, Russia banned Facebook and other social media sites in response to the Ukraine crisis. The same could easily happen to Alphabet's YouTube. There are already several countries where Alphabet's services are restricted to one extent or another. If more were added to the list, it could cost Alphabet on the top line.
Legal risk. Alphabet's strong competitive position makes it a natural target for anti-trust lawsuits, which it has faced in the past. Occasionally, it has paid out. For example, it had to pay $270 million to settle a lawsuit over ad tech in France. That fine was not huge as a percentage of Alphabet's total profit, but bigger settlements could pose a threat to the business.
Macro concerns. There are some macro trends today that are unfavourable to Alphabet's stock, but not necessarily its business. Chiefly interest rate hikes. The higher interest rates go, the less desirable growth becomes. The reason is that higher treasury rates mean there is more return available risk free. In a discounted cash flow analysis, higher interest rates reduce the present value of future growth considerably. This is bad for growth stocks like Alphabet, particularly if they trade at premium prices in the stock market.
All of the risks above are worth keeping in mind. Alphabet definitely has vulnerabilities, and some are pretty big. Nevertheless, the overall package appears very much worth it. Offering high growth, a solid competitive position and a healthy balance sheet, GOOG is one of those stocks that's worth holding long term. It doesn't hurt that it's also a little cheaper today than it was in the recent past, either.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of FB, GOOG, BABA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.