Alphabet Inc. $GOOG
My Investment Checklist
1. Is the company undervalued?
Google is by every quantitative measure, a wonderful business and quite possibly the best company on the planet. It’s unfathomable to think Mr. Market is allowing investors to buy the stock at below a market multiple. Conversely $GOOG is not impervious to macro-economic factors, in fact one could argue that advertising is a fairly cyclical business. Having said that, Google has a best-in-class moat and an infinite runway for growth. If the future resembles anything close to the past, then $GOOG is grossly undervalued at current levels.
2. Can I easily explain what the company does?
I cannot easily explain what Google does; they have several bets running the business gamut. Candidly I would be extremely weary of anyone who claims to have a deep understanding of all Google’s offshoots.
Nevertheless Advertising and Cloud computing make up ~89% of their revenues. These businesses are easy to grasp, even for a simpleton such as myself. Google leans on YouTube and their search engine to attract third party advertisers. On the other hand Google offers outsourced enterprise infrastructure ie; servers, storage, and communication equipment with their Cloud segment.
3. Does the cash flow statement line up with income statement?
Yes, cashflows have been considerably higher than reported earnings:
Most of their excess cash went towards share repurchases, capital expenditures, the purchase of outside securities, and acquisitions. I have absolutely no issues with these capital allocation decisions. The buying and selling of securities is done to generate incremental yield on cash and hedge out FX risk. Additionally the acquisition spend was so insignificant (only a mere $1.1B) that it’s not even worth drilling into.
4. Is the Balance Sheet Healthy?
Total Cash: $139.6B
Total Debt: $14.B
Current Ratio: 2.93
MOTHER OF ALL FORTRESS BALANCE SHEETS!!!!
5. How profitable is the business?
Gross Margins: 56.94%
Operating Margins: 30.55%
Net Margins: 29.51%
Those margins looking thiccc with three c’s!!! With that said 2021 was an unusually favorable year for $GOOG, so it’s likely there will be some margin compression in the future. Here’s what they’ve averaged over the last 10 years for reference:
Even baking in some mean reversion, there’s no doubt $GOOG is an exceptional company! Moreover their Cloud segment is still losing money, so it wouldn’t be unreasonable to assume high 20’s EBIT margins once that business inflects profitability.
6. What is the company’s growth potential?
10-yr Revenue CAGR: 21.1%
10-yr Operating Profit CAGR: 18.99%
10-yr FCF CAGR: 17.51%
It’s impossible to analyze this company without getting a finance boner, absolutely breathtaking!!! To play devil’s advocate Google is now a $1.54T business, so I have serious doubts that 20% growth is in the cards moving forward. Notwithstanding advertising, while lumpy should keep growing so long as people keep using Google as their primary search engine. Furthermore Cloud grew ~44% YOY and has a massive runway left. This is all without mentioning their “other bets” which include autonomous driving, payment processing, and whatever else management is keeping under wraps. All in all, I would anticipate double digit growth at a minimum for the rest of the 2020’s.
7. Is management rewarding shareholders?
$GOOG doesn’t offer a dividend, however they just announced a $70B share repurchase program! Additionally the company is expected to achieve over $70B in FCF in the next twelve months, but let’s be conservative and assume $65B in buybacks moving forward. It’s also important to consider stock-based compensation, which was $16B last year and has increased ~12% per year for some time. Therefore a modest investor can assume $47B (on net) returned to them, which works out to a ~3% total shareholder yield. I hate to sound like a broken record, but again $GOOG scores high marks!
8. How does the company stack up against their peers?
Google is a unique enterprise, but Facebook $FB is most similar in that their core businesses are advertising:
$FB EV/Sales: 4.53
Operating Margins: 39.6%
I’m not going to lie both companies seem like attractive risk-adjusted bets and there’s no clear winner here. While $FB is priced at a deeper discount, they face more headwinds near term. Additionally $FB is ramping up their spend and on a forward basis there isn’t much of a valuation discrepancy; 14X EBIT for $FB vs 16X EBIT for $GOOG. From a qualitative standpoint I think $GOOG is a better wager, because their moat is more impenetrable and their “other bets” intuitively seem less likely to fail.
9. What’s the counter argument?
The counter argument is that there will be a slowdown in advertising spend moving forward and as a result earnings will disappoint to the downside.
I don’t dismiss this argument for a second, a looming recession makes perfect sense. There’s white hot inflation, interest rates skyrocketing, and a potential World War 3 scenario unfolding. Notwithstanding $GOOG is an extremely durable company that investors can take a coffee can approach to. Additionally the stock is priced quite reasonable, so high single digit growth wouldn’t exactly be the end of the world.
10. Is there something I think the market may be missing?
$GOOG sold off after earnings, as they reported a drop in EPS YOY. This strikes me as a surface level overreaction. The core business remains strong and operating earnings were actually up ~22% YOY:
Anyone with a brain should be able to cut thru the EPS noise, but for whatever reason Mr. Market was not satisfied with 22% growth. Shame!!!
My base case is as follows 10% EBIT growth annually, a 3% total shareholder yield per year, and a 20X EV/EBIT exit multiple in 5 years. This works out to a ~16% expected CAGR, which is quite tasty. Additionally $GOOG is uncorrelated from every other holding in my PA and would be by far my highest quality stock. For these reasons I will likely establish a position during my next buy cycle. It should also go without saying that this is not a recommendation to buy the stock, please do your own due diligence as I’m just some random guy on the internet.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice