Investment Idea #3 - Alphabet / Google

One idea per month to get to 30. We are at 10%!

Feb 07, 2023

We aim to publish one investment idea per month. This is our third idea today. We have been writing about investments since 2006 mostly focusing on value investing philosophy, market trends, dividend stock screens and occasionally, we have single stock discussions.

In 2022, we started to share profitable investment ideas and our differentiated views on valuations and the markets. Our previous stock idea is up c.50%! We hope you will like this one too!

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Idea #3: Alphabet / Google

Alphabet / Google (ticker: GOOG) needs no introduction. The company is the largest search engine in the world and the giant in the world of online advertising. It controls 40% of the online advertising market while Meta / Facebook has another 20%. Today, GOOG generates the bulk of its revenue from ads via search and its own services (such as Gmail) and Google Networks - websites that hosts its ads. GOOG also provides a slew of critical services that we all know well: Youtube, Google Maps, Android, Chrome and DeepMind amongst many others. In 2015, CEO Larry Page announced that a parent company Alphabet will be created to house Google and its sprawling empire of subsidiaries.

Thanks to shrewd business strategies and acquisitions, GOOG has managed to grow phenomenally almost without interruption from the beginning. The world might not have seen such a growth juggernaut. It has one quarter (or maybe two) of revenue decline since IPO! The company grew well above 20%YoY for more than a decade and continues to grow into new verticals which it can. These include cybersecurity, cloud services and A.I. enabled voice search could become very big with proliferation of smart speakers in our homes. Despite recent noise about chatGPT and upcoming competitors, we believe the company will manage this transition better than it did during the PC-to-smartphone switch years ago.

One test of a strong business moat is how our lives would be impact if hypothetically, the company cease to exist. For example, what if there had been no Pfizer, how would our lives have changed? Well, maybe a significant percentage of us wouldn’t be alive since there we won’t be vaccinated for COVID-19. Similarly if Alphabet / Google disappears today, a billion or more people including most of us here will not be able to function.

So, the question is, what if chatGPT disappears today?

Meh, let’s see what’s new on Google News.

1. Fundamentals

We know that GOOG makes money predominantly via ads. To further break things down, we can think of the following five buckets (courtesy of FourWeekMBA):

Amazingly, GOOG generates more than the GDP of Singapore with c.70% of its revenue from search and Google Networks, platforms that uses its Google to manage advertising. The other three buckets are important by themselves. Youtube, something most kids cannot live without today, Android, something most phone users cannot live without today and lastly Google Cloud, an upcoming formidable competitor to Amazon’s AWS and Microsoft’s Azure. Perhaps someday, most businesses cannot live without.

Using Gurufocus, we have compiled the following snapshot of GOOG’s important financial numbers and ratios:

Revenue (2022): c.USD282bn
3 year revenue growth 23%
Gross margin 55%
Operating margin 26%
ROE 24%
FCF yield 5% (today)
Net cash on balance sheet c.USD90bn
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2. Technicals

GOOG peaked at c.$150 and is currently at c.$100. In market cap terms, it is USD1.3trn today but 2trn at its peak. There is definitely potential to hit USD2trn again given the earnings prowess described above. It bottomed at $84 in Nov 2022. At the height of covid in Mar 2020, it was c.$50. The stock went for a 20 for 1 split in July 2022 and these are no.s post split.

Based on the above, the risk reward for GOOG is 1:1 if we use the Mar 2020 covid low but we could argue that it is very difficult to revisit those levels while the upside can be much higher as justifiable by valuations. See next section!

3. Valuations

GOOG generates c.USD70bn in free cash flow annually. This was USD11-13bn ten years ago in 2012. At such growth rate, it should generate USD100bn in FCF annually in a few years, or minimally USD80bn. Against its market cap of 1.3trn today, this is 6% FCF yield or if we deduct its c.USD90bn of net cash, that is c. 7% FCF yield. This is the highest FCF yield amongst the original FAANG names.

Triangulating with other valuation metrics, it is currently trading at Dec 23 PER of 17x and Dec 23 EV/EBITDA of 10x which is at the low end of its own historical range. GOOG has generated very high ROE over the last 10 years and that is targeted to hit 25-26% in 2023.

Simplistically, using analysts’ estimate of its Dec 24 EPS of $6 and giving it 25x, GOOG’s intrinsic value will be $150 which was its peak as discussed above. As such, we have c.50% upside.

Huat Ah!

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