Portfolio Pillars #1: Alphabet🔎
A must-own tech giant with minimized risk and rapid earnings growth
Alphabet is about as close as one can come to owning a monopoly, regardless of how much they try to downplay it.
Google’s search engine had a market share of 92.5% as of May 2022 and should continue to dominate for the foreseeable future due to superior performance and unparalleled capabilities. Meanwhile, the Chrome browser claims a 65% market share, dwarfing the 19% controlled by Safari. Chrome’s current browser domination was largely the result of Sundar Pichai, who correctly theorized that Google’s lack of a browser may threaten the dominance of its search engine. At the time, Internet Explorer by Microsoft was one of the most popular browsers. Microsoft was actively looking to create its own search engine (Bing) and lessen the chokehold Google was formulating. Thanks to Sundar’s insistence, Chrome was created, and now thrives as a sleek, lightning-fast browser.
A competent and visionary leadership team is integral to the success and expanding economic impact of a corporation. Sundar, who rose the corporate ladder from a mere product manager to the CEO in the span of roughly 10 years, exhibits many of the most desired leadership traits. Most notably, humility, an ability to unify his employees, and visionary thinking. According to Glassdoor, Sundar is one of the highest rated CEOs with a 92% approval rating and was included in Top CEOs 2021. Sundar attended three universities before taking a job at Applied Materials: IIT Kharagpur (in India), Stanford for an MS, and University of Pennsylvania for an MBA. Seen most clearly in his congressional hearing in 2018, Sundar displays a great deal of composure, especially while tricky questions are fired at him. Inside of Alphabet, he is said to be more conservative and deliberate in his decision making. As a potentially substantial portion of one’s portfolio, this isn’t a bad thing. In numerous interviews he has stated that he wishes to invest in building out more AI functionalities across Alphabet’s products. This isn’t nearly as bold as Mark Zuckerberg’s metaverse bet, but that’s precisely why investors should love it.
As of early 2022, the majority of Alphabet’s revenue is derived from its advertising business (81% to be exact). Digital ad spend accounted for 64.4% of total advertising in 2021 according to GroupM. This proportion should only grow as more businesses realize digital advertising is cost-effective, offers unparalleled targeting, and broadens the reach of one’s campaign. Google accounted for roughly 28.6% of total digital advertising revenue generated in the United States, sharing a triopoly with Meta and Amazon. Over the next decade, digital advertising is forecasted to grow at a CAGR of 10.34% until 2031. Applying this growth rate to Alphabet’s current revenue base of $209.49 billion results in $560.41 billion in revenue for 2031. Simply retaining their market share will result in steady growth and a predictable revenue stream off of which Google Cloud and “Other Bets” can expand upon to ultimately catalyze the next leg of growth for the company.
YouTube, one of the world’s dominant social media platforms and arguably the most defensible, has been (and should continue to be) a major cash cow for Alphabet. YouTube is a platform that I, like hundreds of millions of others, use on a daily basis. With over 2.56 billion active users, YouTube dominates the longer form social media format, offering an incomparable variety of videos on nearly any topic imaginable. YouTube’s impressive 45% YoY revenue growth in 2021 shows that its ad market isn't yet fully saturated and the company is constantly finding new ways to further monetize its user base. As YouTube’s growth has outpaced that of its parent company, it’s becoming an increasingly large portion of Alphabet’s total revenue, reaching 11.2% in 2021. YouTube has thrived through decades of disruption in the social media space (most recently with TikTok) and should experience minimal problems going forward. Innovations such as YouTube TV and YouTube Music have further separated YouTube from its expanding list of competitors. Thus, I believe YouTube will play an integral role in providing entertainment, education, and advice for decades to come while acting as a major profit generator for Alphabet.
Alphabet’s acquisition track record is nothing short of superb. YouTube, which they acquired in 2006 for $1.5 billion, is commonly regarded as one of the best acquisitions ever. With the company recently grossing almost $30 billion in revenue, their purchase has paid for itself many times over and generates substantially more in earnings each year than the original transaction fee, an incredible feat. Due to their international brand recognition and nearly unparalleled access to internet users, Alphabet can acquire companies and drastically expand the reach of their products. The relatively recent acquisition of Fitbit is one such example of the company employing this strategy. With $134 billion in cash and cash equivalents and only $29 billion in debt, Alphabet has one of the most enticing balance sheets of any publicly listed company. Their war chest of cash offers stability, opportunity for significant investments in R&D, and high acquisition velocity.
Google Cloud, the third largest cloud computing service (behind Amazon’s AWS and Microsoft’s Azure), continues to outpace the growth of both its parent company and competitors in the cloud industry. In 2021, it grew at a blistering 47% YoY. Unlike AWS, which generates a great deal of Amazon’s operating income, Google Cloud produces quite sizable operating losses as it pushes to take market share from its rivals. Thomas Kurian, a former 27-year SAP executive, currently runs the segment. His reputation as a leader hasn’t exactly been positive. For instance, Google Cloud was nicknamed by some as “SAP 2.0” as Kurian has increased his sales team by a multiple of 3 in a mere matter of years and altered the compensation system. Google Cloud salesmen received a base salary cut accompanied by huge bonuses for closing deals. Insiders have called the Google Cloud work environment cutthroat and a polar opposite from the rest of the Alphabet ecosystem which focuses on product optimization over revenue milestones. Regardless of this managerial risk, Sundar has supposedly given Thomas Kurian free reign as long as Google Cloud grows rapidly and takes market share from competitors. The cloud computing sector, luckily for Alphabet, doesn’t seem to be a zero sum game and many functionalities have yet to be discovered. Numerous (if not the majority of) enterprises including Ford use a variety of clouds and therefore have no allegiance to a single provider.
An effective and intuitive office suite can play a critical role in a company's success. Google Workspace, composed of Gmail, Meet, Calendar, Docs, Sheets, Slides, and many others, is an incredibly useful and relatively affordable software suite reported under the Google Cloud segment. Google has employed an ingenious strategy to scale Workspace to over 3 billion users; Workspace is free for individuals and educational institutions, enabling Google to onboard the next generation of software engineers and internet users for free. High schools across the U.S. rely on Docs, Slides, Meet, and Gmail in order for their classes to run smoothly. When these students grow up, many will likely wish to stick with the office suite they have used throughout their childhood: Google Workspace. According to Statista, Workspace claims a 60% share of the office suite market while Office 365 by Microsoft claims the other 40%. This duopoly should begin to shift more in favor of Google in the coming years as students who grew up with Workspace enter the workforce or launch a startup. Workspace’s sleek and easy to use design and Microsoft’s lack of innovation should only increase its dominance. In terms of pricing, the two suites are relatively similar. The salient difference comes from Workspace lacking the unnecessary complexity of Office 365. I believe the accelerated emergence of startups will result in increased adoption of Workspace.
Google Cloud has emerged as one of Alphabet’s crown jewels and will likely play an integral role in Alphabet’s next leg of rapid growth. The global cloud computing market is expected to grow at a CAGR of 16.3% to nearly $1 trillion by 2026. Considering that it is growing faster than the overall industry, retention or expansion upon its market share would result in revenue in excess of $100 billion by 2025 or 2026. Slapping on a 10x sales multiple for a fast-growing, high-margin business results in a $1 trillion valuation for Google Cloud alone. Given Alphabet’s current enterprise value of $1.43 trillion, this could be one of many notable catalysts for the stock. Google Cloud’s recent acquisition of Mandiant for $5.4 billion should bolster its cybersecurity offerings and further differentiate it from the likes of AWS and Azure. As the Cloud Computing segment starts to mature and Alphabet lessens its spend on grabbing additional market share, Google Cloud should emerge as a highly profitable and stable revenue stream for Alphabet.
In recent years, Google has been pushing deeper into the hardware space and is quickly becoming a formidable competitor to Apple and Samsung, the two dominant players. At the recent Google I/O 2022, Google unveiled the Pixel 7, the Pixel Watch (likely designed in part by Fitbit’s team), and a tablet that will be released in 2023 (in addition to many other things). While overtaking Apple’s dominance in consumer electronics is somewhat of a pipe dream, Google could certainly become a top 3 player by incorporating lots of AI and leveraging its Android operating system, which is used in 87% of smartphones globally. As the smartphone market continues to flourish, new brands are likely to emerge and run on Android. Additionally, Apple’s competitors seem to be carving out their own niches and catching up in terms of performance. For instance, the Pixel 6 is far cheaper than competing iPhones while offering somewhat comparable performance. In Q1 2022, Google’s North American market share in the smartphone market increased by 380% QoQ. With the increased adoption of Pixel branded hardware as well as any product running on an Android OS, Google Play revenue (Google’s version of the App Store) should grow substantially.
On a related note, Alphabet launched a data plan called Google Fi in 2016. Although it may seem like a competitor to T-Mobile, AT&T, Verizon, and the other large providers, Google Fi operates as an MVNO (mobile virtual network operator) and therefore runs on multiple providers within a certain country, seamlessly switching between them based on which has the best coverage. Google Fi is currently a relatively small service but could gain traction in coming years and materially boost Alphabet’s revenue.
The holy grail of Alphabet’s future, “other bets” is composed of some of the most innovative and promising startups. Most of these businesses, hatched out of X, are guzzling capital and are currently viewed as liabilities by Wall Street.
X, the moonshot factory, was formed by Larry Page and Sergey Brin in 2010, and has since generated some of the most profound technological innovations seen by mankind. No other company I’ve heard of has an in-house startup incubator, as it’s simply too capital intensive. While many of these bets may not pay off for a couple years, they’ll almost certainly pay dividends to shareholders decades from now when Alphabet’s revenue streams are (hopefully) much more diversified. Therefore, buying Alphabet stock at current valuations essentially grants you free ownership of moonshot ideas that should statistically result in at least a few winners.
One such potential winner is Waymo, the autonomous driving startup that operates the first autonomous vehicle network. In 2018, Morgan Stanley valued Waymo at $175 billion. That valuation has since contracted significantly as Waymo turned to external funding in 2020 and raised $3.2 billion at a valuation of $30 billion. In June of 2021, Waymo raised another $2.5 billion at an unknown valuation. Seeking external capital allows Waymo to receive guidance from blue chip VC firms as well as large corporate backers for only a minimal loss of equity.
Waymo is currently rolling out its Robotaxi service, Waymo One, which could eliminate the need for the middlemen between us and our destinations that are taxi/ride-hailing drivers. In addition to this, they are working on Waymo Via, an autonomous trucking solution to deliver goods on a pay-per-trip basis. An autonomous taxi network and trucking service, if scaled, will be incredibly lucrative and would likely drive Waymo’s valuation back into the hundreds of billions of dollars. Waymo could begin generating sizable amounts of revenue in the latter half of the decade as autonomous vehicles capture public and government confidence.
The convenience and velocity of delivery services is only going to increase. One such startup working to do just that, using drones, is Wing. They recently announced the completion of 200,000 deliveries and already operate in 3 countries (Australia, Finland, and the United States). Like many of Alphabet’s most prominent startups, Wing graduated from X, the moonshot factory. Wing was the first drone operator certified as an air carrier by the Federal Aviation Administration and has since been on a torrent to broaden its reach. Most recently, Wing partnered with Walgreens to deliver goods in the Fort Worth area, KFC to deliver meals, and FedEx to deliver packages. A Google blog post stated that, “Integrating drone delivery into daily life isn’t just an added convenience. It holds the promise to reduce traffic congestion, accidents, and greenhouse gas emissions while growing sales for businesses all the while giving people more time back in their busy lives.” Thus, Wing has the opportunity to disrupt the potential $1 trillion delivery market dominated by Doordash, Uber Eats, GoPuff, and numerous other services that rely on drivers.
Alphabet’s startups span across every industry, including life sciences. Verily, which graduated from X in 2015, has emerged as one of Alphabet’s most promising initiatives in the biotech space. Verily operates numerous projects, spanning from Verily Value Suite which unlocks care improvements through precision analytics for physicians to Onduo which is currently making a push into the telehealth space to Granular, a stop-loss insurance company. Like many of its fellow Alphabet in-house startups, Verily has raised $2.5 billion in external capital through multiple rounds at unknown valuations. Verily has a massive runway for growth given the various major projects it’s operating and already generates hundreds of millions of dollars in revenue.
The three startups described above are a mere fraction of those reported under Alphabet’s “other bets” division. Others include DeepMind, which focuses on using AI to solve some of the world's most complex challenges and is composed of some of the most talented/coveted engineers. Another, Sidewalk Labs, focuses on developing hardware and software to create smart cities while Calico focuses on combating aging and diseases that cause it. These ventures, which are inherently speculative yet revolutionary, could potentially provide Alphabet with additional revenue streams that catapult the stock higher and expand Alphabet’s reach outside of advertising.
A considerable portion of today’s largest enterprises have corporate venture capital arms (also known as CVCs), a secular trend that accelerated materially in the 2010s. Alphabet is no different, apart from the fact that it runs three: GV, CapitalG (which focuses on larger, growth-stage technology companies), and Gradient Ventures (which focuses on AI).
GV (previously known as Google Ventures), operates as the most active and successful venture capital arm of Alphabet, investing in disruptive startups. With over $8 billion in assets under management, if Alphabet isn’t able to break into an industry itself or gets beat to a revolutionary technology, it can simply invest in it.
In 2017, Alphabet was the most active corporate investor, and has continued to funnel sizable amounts of capital into innovative businesses. Thus, major Alphabet investors should sleep better at night knowing that the company is investing in future giants and will meaningfully benefit from emerging technological advancements.
As a brief note on company culture, Alphabet attracts some of the most brilliant, hard-working employees due to its prestige and lush benefits. Each year, Google performs an internal “Googleist” survey which them to measure employees satisfaction with compensation, execution, and vision of the company. Utilizing and responding appropriately to the results should allow Google to optimize its work conditions, reduce bureaucracy and attrition, and increase productivity.
Alphabet’s ecosystem of products and services has continually expanded over the past two decades. The success of Amazon Prime has shown that a subscription service offering benefits across an ecosystem can lock customers into that ecosystem. For instance, Prime users are inclined to shop on Amazon, buy groceries at Whole Foods, stream movies on Prime Video, and listen to music on Amazon Music. A similar service for Alphabet, offering discounts on hardware, free rides each month on Waymo, and free Youtube Music would likely have a similar effect.
Leveraging its surplus of cash, Alphabet can use this economic downturn to make strategic acquisitions at cheap valuations. A few enterprise software acquisitions, such as Asana, could greatly strengthen the already powerful value proposition of Google Workspace. Alphabet could also look to make acquisitions in industries they have no previous connection to. Purchasing an EV manufacturer such as Lucid, which trades at an enterprise value of $27 billion, would allow Alphabet to directly compete with the Apple Car that is rumored to be released between 2025 and 2027. Lucid vehicles could then be used to compile the Waymo One fleet, reducing the need for Waymo to use vehicles from other manufacturers. With very little business in the Fintech industry, a Robinhood acquisition would unlock more financial data about customers and enable Alphabet to build out a suite of financial products. A few strategic acquisitions over the next two years would be a sign of exceptional management and is certainly something to watch for.
It’s now time to look at Alphabet from a more quantitative perspective. Starting with revenue, Alphabet has grown sales at a CAGR of 23% over the past 5 years. Were this to continue until 2030, revenues of $1.3 trillion+ would be achieved. Funny enough, in Q1 2022, Alphabet grew its revenue precisely at 23% YoY. A 15% CAGR, which seems to be the current consensus due to recession fears and an ad market slowdown, would yield revenue of $790 billion in 2030. What analysts fail to consider is the potential growth in many of Alphabet’s “other bets”. UBS estimates that by 2030 Waymo alone could be generating revenue in excess of $100 billion. With Google Cloud’s explosive growth and a few “other bets” taking off, Alphabet should feasibly crush analysts estimates and compound in excess of 20% a year in the second half of this decade.
Alphabet’s ridiculous free cash flow generation, which amounted to $67 billion in 2021, has allowed them to aggressively repurchase shares. In 2021, these share repurchases used up 75% of the company’s FCF. Instead of repurchasing so many shares, Alphabet could look to grow inorganically through large acquisitions, as mentioned above. Unfortunately, Alphabet has historically shied away from such opportunities. Meanwhile, Microsoft has been snapping up giants left and right, most recently with the $68.7 billion Activision Blizzard deal. Microsoft’s quest for inorganic growth may motivate Alphabet to alter its strategy as overlapping products/services between the two grow.
Shown above is a discounted cash flow analysis of Alphabet performed by Simply Wall Street. The comical part is that Alphabet has grown its FCF at rates far in excess of the rates projected later in the decade. Since 2010, Alphabet’s FCF has grown at a 24% CAGR. Even with Wall Street’s conservative estimates for the annual FCF growth rate, nearly $1 trillion of present value 10-year free cash flow is expected to be generated.
According to my own calculations, which used a higher discount rate and modified FCF growth rates, the present value of Alphabet’s 10-year free cash flow is $1.24 trillion. For 2022 and 2023, I chose growth rates well below the current analyst consensus due to an imminent recession that will inevitably cause a digital ad slowdown. I expect growth rates to accelerate in the latter half of the decade as Google Cloud achieves stable profitability and Waymo begins raking in high margin revenue.
High insider ownership is usually a sign of internal confidence in a company’s prospects and helps to better align shareholders with employees. By holding sizable amounts of equity, management is inclined to maximize shareholder value, as they themselves are shareholders.
15.2% of Alphabet’s outstanding shares are held by insiders, equating to over $213 billion. Considering Alphabet’s size, this is extraordinary and signifies that management is motivated by much more than just a salary.
In terms of valuation multiples, Alphabet looks pretty attractive given the extensive growth runway ahead. The P/E of 19.42 is slightly below the average S&P 500 P/E of 21.92 (between 1981 and 2020). The forward P/E of 19.01 indicates that earnings aren’t expected to grow much this year, likely as a result of the ad market slowdown I mentioned earlier. Both trailing-twelve-month and forward P/CF ratios look enticing at 15.02 and 13.44 respectively. The major caveat here is that parts of the business aren’t yet optimized for profits, meaning these multiples are even more compelling than they seem at first glance. Thus, if the TTM P/E is to fall below 15 in the event of a recession and substantial stagflation, I’d recommend accumulating as many shares as possible.
There are unfortunately a plethora of risks that Alphabet faces over the coming decades. These include antitrust fines and a potential breakup of the company. In 2021, Alphabet was fined $2.8 billion by the EU’s General Court due to the favoring of its own in-house price comparison tools. While the FTC is currently preoccupied with Meta and Amazon, Alphabet certainly could be their next target. Yet, over the decades of internet use, there has yet to be a large tech breakup. The most notable was AT&T in 1984, but that was a far more blatant monopoly than Apple, Amazon, Alphabet, Meta, and Microsoft are today. One analyst has even argued that an Alphabet breakup would result in considerable upside due to each independent business being receiving higher a valuation.
By owning the two most valuable search engines in the world (Google and YouTube), both of which should grow for the foreseeable future, Alphabet offers investors unparalleled stability in the rapidly evolving and cutthroat tech industry. While growth rates can feasibly be measured and tracked, durability is significantly more challenging to forecast. Alphabet’s mission of organizing the world’s information and making it universally useful/accessible and the perpetual need for search functionality compel me to believe it will thrive for decades to come, providing excellent returns to long term investors.
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