Google Stock (NASDAQ:GOOGL)
Over the last decade, Google (NASDAQ:GOOGL) has generated excellent top-line growth. However, the company’s profitability measures are not expanding on the scale because it is attempting to diversify its revenue streams, which are not cheap. Google has invested $200 billion in R&D over the last decade, but digital advertising revenue still accounts for the majority of Google’s revenue. The company recently unveiled its Bard generative AI tool, which some believe can outperform ChatGPT. But, for the time being, I’d rather sit on the sidelines and see how the generative AI race develops, as well as the company’s new investments, especially given the limited upside potential at the current stock price.
Information About the Company
Alphabet, formerly known as Google, is a firm that was created in 1998 by Sergei Brin and Larry Page in the Communication Services industry. Alphabet now includes Google as an operating unit. The corporation is the clear market leader in the search engine sector, handling more than 90% of all global search inquiries.
According to the most recent 10-K report, digital advertising accounts for over 80% of the company’s sales.
Financials
To begin with financial research, I usually zoom out to see how well a company captures favorable secular trends. A clear secular tendency for technological organizations like Google is a shift to digitalization, which has been aided substantially by the Covid-19 pandemic.
Zooming out 10 years, the company delivered a strong financial performance, with a nearly 20% revenue CAGR over the decade. Except for free cash flow [FCF] ex-stock-based compensation [ex-SBC], the company did not demonstrate margin expansion with increasing scale.
Because of rising R&D spending, which has been significantly greater on average than in FY 2013, the company has not demonstrated a gain in operating margins during the last decade.
Given that digital advertising accounts for a substantial amount of Google’s revenue, a large portion of sales invested in R&D in recent years is extremely sensible. And, while the corporation has succeeded in diversifying its revenue streams, the rate of revenue mix shift is gradual, considering the significant volumes of sales generated by digital ads.
The corporation reduced its advertising percentage of overall sales from 92% in 2013 to 79% in 2022, which is a good indicator in my opinion. Relying only on one revenue stream is dangerous for the organization and exposes it to cyclical factors. As an investor, I believe it is a positive sign that management is proactive in tackling secular developments.
Google has made significant investments in its Google Cloud and Other Bets businesses. Other Bets are in the early stages of commercialization, and the level of uncertainty about their capacity to break even and generate sustainable cash flows is considerable, so I would ignore them for the time being. I’d like to focus on the cloud business, which has grown at a 31% CAGR over the last four years since the company began disclosing Google Cloud revenue separately. The rate of growth was significantly faster than that of Amazon’s (NASDAQ:AMZN) AWS cloud business and Microsoft’s (NASDAQ:MSFT) Azure cloud segment. Despite Google’s lower market share in the cloud sector than its competitors, AWS and Azure face more difficult comparisons.
Given the large market share disparity between Google Cloud and its competitors, as well as evidence of cloud sector growth slowing, I don’t see how Google can become the market leader. What is equally important for me as an investor is that the expansion of the cloud company has already been priced into the stock price. As a result, we should wait for another moonshot from Other Best to burst before the stock price rises dramatically. And there is a lot of doubt about it.
I’m not going to pay much attention to the recent numbers because it’s clear that all companies are negotiating a difficult climate right now, with revenue growth slowing and margins under substantial pressure.
I believe these difficulties are transient rather than long-term, and the company’s balance sheet is strong enough to weather the storm. Even after deducting debt, the cash position is large as of the most recent reporting date. Given the outstanding metrics, liquidity risk is also low.
Over the long term, I believe Google’s financial performance and capital allocation have been good. Still, we must acknowledge that the company’s biggest growing star, the cloud industry, is maturing, and the growth rate will continue to slow. To demonstrate that consolidated revenue growth can be sustained in the double digits, the corporation must demonstrate that at least some of the Other Bets provide reliable cash flows.
Valuation
Google has been extremely generous with share repurchases over the previous decade, spending about $180 million on buybacks, but the corporation still does not pay dividends. As a result, for valuation, I employ the Discounted Cash Flow [DCF] method.
Because selecting underlying assumptions might be difficult, I choose to remain conservative. For WACC, I use the estimate provided by valueinvesting.io and round it to 10%. I have a historical FY2022 FCF margin that I estimate to grow by 75 basis points per year. I utilize earnings consensus projections for the topline, which anticipate sales to expand at an 8% CAGR over the next decade. This is modest, especially given the prior decade’s near to 20% topline growth.
Incorporating all of the assumptions results in a fair value-to-market value ratio of 0.94, indicating that the stock has minor upside potential.
To be safe, I normally undertake value multiples research as well. It also allows me to double-check my DCF results.
In general, I believe the stock is slightly undervalued. It is also worth noting that the assumptions are extremely conservative. If one of the company’s moonshot investments proves to be sustainably successful, the stock price has huge upside potential.
There Are a Few Key Risks to Consider
As previously said, the corporation is heavily reliant on digital advertising revenue. This is dangerous because the company’s total financial performance becomes extremely exposed to unfavorable industry shifts. Digital advertising is also dominated by giants such as Amazon and Meta’s (NASDAQ:META) family of social media apps.
Antitrust investigations are another huge risk that I see. The company has been scrutinized both in the United States and in Europe. This poses significant operational and financial hazards to the organization. Google is subject to fines and penalties, and there is always the possibility that regulators would force the company to split the business or otherwise disrupt operations and synergies.
Finally, as we saw in the “Financials” section of the article, Google invests heavily in R&D. Any indication that these efforts are not paying off will most certainly disappoint investors and prompt sell-offs, putting pressure on Google stock price.
In Conclusion
Overall, I feel Google is a well-managed firm with foreseeable growth prospects, and the stock is currently modestly cheap. However, the company’s growth rate is projected to slow until one of its new products indicates a path to scalability and profitability. I own Google stock, however, I prefer not to expand my position until there is a greater assurance about new items.
Featured Image: Pexels @ Caio
