Hello /r/stockmarket!
Even in these tough times, I keep chopping away at the research and analysis that I always do. Today's write-up is about Alphabet Inc, more commonly known as the parent company of Google (Ticker: $GOOGL). As always, this is my own fundamental analysis, and the write-up that follows. I employ trend research and discounted cash flow analysis, and it is fully up to you if you want to take anything here written as fact. Numbers and information is taken from the 4th quarter of 2017 and earlier. That said, here is my view of Alphabet Inc.
The company
Alphabet is an holding and parent company of many subsidiaries, focusing on technology. What kind of technology you ask? Well, a ton of it. Here is a list of some of the subsidiaries that Alphabet has under its massive technological wing:
- Google, an internet company focusing on it’s famous search engine, advertising business and video service through Youtube. It goes without saying that Google is by far the largest and most profitable of Alphabets businesses.
- Calico, a R&D biotech company
- Chronicle, a cybersecurity and anti-hacking company
- Dandelion, a geothermal energy startup company.
- DeepMind, an Artificial intelligence company
- GV (Google venture), a strategic investment company
- CapitalG (Google Capital), a profit-directed investment company
- Google fiber, a developer for fiber networking and an ISP
- Nest Labs, a home automation company. Develops programmable home appliances.
- Jigsaw (Google Ideas), a tech incubator company, focusing on unique technology
- Sidewalk labs, urban innovation company, developer within infrastructure and urban technology.
- Verily (Google X), life-science research and development company
- Waymo, world leading company in autonomous driving
As you can see, the list of technological focuses is incredibly broad. Alphabet is an ad company that puts all its profits into developing thousands of products to revolutionize the future.
Fundamentals & Forecasts
Alphabet has a annual revenue of $110,8 billion, resulting in a gross profit of $66,5 billion and a net profit (earnings) of $13,9 billion. That is an 24% increase in revenue year to year (y/y). Alphabets numbers are slightly jumbled up recently as this quarter, like many other tech giants in the US following the tax reform of the new year, moved huge amount of international profits into the US. This resulted in alphabets tax rate for Q4 2017 to become 138% of their pre-tax income. We have to adjust for this one time payment, as Alphabet moves that money into the country to invest in their capital expenditure and R&D. The company has a historical tax rate of roughly 18-19%, which is very low. Also of note, Alphabet has during the last 2 years fairly consistently increased their R&D spending by 20% y/y each quarter, really highlighting how the company is putting more and more money into their technology R&D. Their general operating margin is roughly 60%, which is also very high, but not uncommon in the ad market. A last notion to mention is that Alphabet is after their intake of additional saved up international cash very net cash positive, with a war chest of $97 billion. As a huge part of Alphabet is founding its own startups, acquiring other startups that have potential and investing in either one, their huge war chest is a very strong advantage for them to have.
Alphabet is huge. It’s enormous. This makes forecasting complicated as they can have huge swings if their profitability goes down, and it could be very hard to recover. I preface the next message with this, so you as a reader is aware. Alphabet right now has amazing fundamentals. The company is incredibly strong. They have the historical income numbers of a growth company, while being profitable and stable. These are facts that make Alphabet very fundamentally sound.
If we assume that Alphabet reached their growth peak in 2017, and from there have a steady growth slowdown until they run into a complete growth-stop in 2030, as well as maintained tax rate (20%), gross (& operating) margin (60% respective 23%), we still see upside in its current price. These calculations were done at a -3% maturity rate, along with a discount rate of 7%. These are fairly standard industry numbers. Using this pessimistic view of the company in my eyes, seeing no further improvement, the net present stock value would end up at $1199, a valuation upside of 15% after the recent drop. The more realistic scenario is the same, except that we maintain the current growth for the coming year, and then seeing a slower maturity drop until the growth-stop, we see an 34% upside, $1402.
Concerns & Risk
The recent discussions about Alphabet is its issues with TAC, traffic acquisition cost. That is the cost that Alphabet pays to get traffic to their services, where the expense is increasing and margins decreasing fairly rapidly. At the beginning of 2016, the ad revenue of $18 million was hurt by a TAC of $3.7 million, which is an TAC cost of sale of 21% of the ad revenue. These numbers increased to $21.4 million, $4.63 million and 21.6% respectively. Now, at the end of 2017, the TAC expense grows 11.5% faster than the ad revenue. This is clearly a problem for Google as a service, and as their margins fall, this causes real concern about their profitability. If we apply a lowering margin down from a VERY consistent 60% gross margin after cost of sales, down 1% per year down to 53%, we see the net present evaluation drop to 946 per share, a -10% downside. This is a real risk, and is the scenario where Google slowly loses its iron grasp on the ad industry. The very realistic scenario, the middle ground, is where Alphabets margins drop from their consistent 60%, to 56% by 2020. 56% gross margin was what happened this last quarter, Q417, which caused the 10% drop in value along with uncertainties in the overall market. If Alphabet never recovers from this drop in margin, their current valuation is fair. If they recover but slowly struggle down to 56% again, even slowly down to 53%, they have a very slight downside. As you can see, this is a potential problem for Google. It is worth pointing out that this drop is very abrupt, a blip, and is no proof of any sort of a trend. A similar company, Facebook $FB, has a gross margin of 87%, which shows that higher margins is also attainable.
My view
Alphabet has been my personal favorite company since I became an adult, which makes me slightly biased. I am happy to report that my financial knowledge tells me that they also deserve the praise I give them personally. The company is amazing, attaining growth numbers that shouldn’t happen to large businesses like this. Most analysts are right to worry about the recent decline in gross margins, but if these are improved, they should be a catalyst that removes the sliver of doubt that is the only thing holding Alphabets price down. I will most certainly hold Alphabet through that. It is such a diverse business, deep into the future of tech, supported by the greatest ad company this world have ever seen. They are regulated hard to leave their main product, Google search engine, unbiased as if they were greedy with it, could dominate any market. That power is impossible to put a $ on.
I personally believe that Google is a perfect buying opportunity for a very long term investment. They will get their margins back on track, their excellent management fully understand this. It might not be the next quarter, it might not be the quarter after that. However, if we assume that their operating margins look very realistic, bordering pessimistic, and that they recover their margin issue over the next 4 years, their net present stock value is $1236, a 18% upside. This doesn’t make Alphabet a snap purchase, but it makes them a fair purchase. When you buy Alphabet you buy a sliver of the future. They have their hand in every single futuristic technology, everything from Biotech to AI and self-driving cars, to VR/AR to the internet of things. They are industry leaders in all of these (barring biotech, tough industry). When these markets become profitable in the future, your good purchase of Alphabet today becomes an excellent hedge into the R&D of the future.
I bought Alphabet right before the drop of 10%. My only mistake is that I did not buy more. However, it turned out fine since it tanked. I am happy people doubt their margins because WHEN they recover, I will own a lot more Alphabet than I would have without the drop.
Thanks for reading
If you would like the model, I’ll be happy to send it over.
Submitted February 11, 2018 at 02:48PM by lykosen11 http://ift.tt/2snt6AT
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