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Google parent Alphabet is a class investment right under your nose
A juggernaut in its field yet still growing fast, Google-parent Alphabet (GOOG) remains an outstanding investment opportunity with large technological moats and very attractive operating profit margins of 30%.
Investors have been offered some exciting prospects over the past year or so with those companies coming to the stock market grabbing a lot of attention. Yet sometimes investors are in danger of missing what is right in front of their nose, namely companies with a long track record of being a listed business and still delivering growth such as Alphabet.
Relative newcomers to the stock market like cloud computing analytics business Snowflake, delivery platform DoorDash, bitcoin broker Coinbase, online retail firm THG (THG) and others may have their own relative merits but few have the growth scale and profits power of Alphabet, which processes around 90% of all online searches in the US and owns the YouTube video platform.
MEGA TECH GROWTH
In the three months to 31 March 2021, Alphabet saw quarterly sales surge 34% year-on-year to $55.3 billion on bumper digital advertising spend by businesses looking to expand during the pandemic reopening. This was an acceleration on the previous quarter’s 23% revenue growth and 7% ahead of expectations, according to analysts.
Google Services, the dominant part of the business, saw sales rise 34% to $51.2 billion, within which Google Search and other advertising revenues grew 30% to $31.9 billion. YouTube advertising revenues soared 49% to $6 billion, led by direct response marketing and a shift of TV advertising budgets towards YouTube as consumer brands look for better ways to connect with a more fragmented audience spending more time on their phones and less in front of the TV.
This is not new; TV has been losing advertising spend share for years. For example, since 2012 TV’s advertising share has gone from 34% to about 25%, according to data from researcher Group M, and is expected to continue drifting lower out to 2024. It’s the same story for radio, billboards, direct mail and other traditional forms of advertising.
The contrast with online advertising spend could hardly be more stark. Its share of the global advertising pot has increased from 16% in 2012 to about 50%, with projections of 60%-plus share by 2024. Online advertising is also widely believed to have held up far better during the pandemic, when marketing budgets were unsurprisingly cut across the board. This was evidenced when Alphabet revenue grew by nearly 13% during 2020 to $182.5 billion.
Operating profit in 2020 grew by more than 20% to $41.2 billion, metrics that have also accelerated in the first quarter this year. Operating profit growth was 106% in the three months to 31 March 2021 to $16.4 billion, beating expectations by 39% and lifting the profit margin from 19% to 30% year-on-year.
Some analysts may still wonder if Alphabet’s income streams are diverse enough, so heavily dependent on advertising as it is, yet any predictions of an end to the glory days of online search and advertising look premature. That said, Alphabet has other growth levers to pull, Google Cloud the main one.
This part of the business is the world number three supplier behind Amazon’s AWS and Microsoft’s Azure, providing the hosting infrastructure and software tools and applications that allow organisations to migrate to cheaper and more flexible cloud operations.
Google Cloud is currently loss-making but is growing fast, with first quarter revenues up 46% to $4 billion and operating losses almost halving to $974 million.
You don’t grow to the size of a small nation’s GDP without locking horns with regulators, and Alphabet does face antitrust challenges ahead.
Alphabet has been accused of hurting competitors by giving priority in its search results to its own products, like shopping advertisements or local business listings, while its complex ecosystem also makes it difficult for alternative operators.
The tech giant also owns the world’s dominant smartphone operating system, Android, which runs close on nine out of every 10 phones worldwide, and critics complain that it uses this dominance to strong-arm partners to bundle Google apps, like its search engine and map service, into their offerings. Two years ago, the EU’s executive arm fined Google a record $5 billion for unfair business practices around Android.
If the worst came to pass Alphabet could possibly restructure itself under regulatory pressure but it would likely fight tooth and nail and a legal battle could drag on for years. Most analysts don’t see that happening, instead believing some form of deal would be struck that would suit all parties to some degree, albeit with possible financial penalties.
We can say with confidence that Alphabet remains a financially strong business with a $121 billion net cash position. It has the tech expertise, a talented workforce and the financial resources to back emerging developments and opportunities. On a next 12-months price to earnings multiple of 25.8, based on Refinitiv data, we firmly believe that Alphabet is an investment worth backing for the medium and long-term.