Alphabet Inc.


Ticker:                            GOOG/GOOGLNature of Business:    Technology ServicesLocation :                              USA
Recent Price:           $2,267.44     52-Week High/Low: $2,289.04/1,209.71Estimated Fair Value:      $1,932-$2,348.10
Expected Return:      12.6%Consider Buy:                   Below $2,348.10Business Risk:               High
Financial Risk:      MediumEconomic Moat:               WideCorporate Governance: Strong

Company Overview
Alphabet Inc. (ALPHABET), a technology company headquartered in the USA, has presence in Africa, Asia, Europe, Latin America and North America.   It was originally established as Google LLC by Larry Page and Sergey Brin in 1998. ALPHABET  is a diversified holding company that emerged from the reorganisation of Google LLC in 2015. It provides products such as search engine, online advertising, cloud computing, internet access, autonomous driving, biotechnology, software and hardware.  The company’s subsidiaries include Google, Calico, Verily, Waymo, X and Wing.

ALPHABET operates in industries characterised by fast-paced technological change; its continuous investment in machine learning and artificial intelligence has enhanced existing products and broadened its product portfolio. Acquisitions, joint ventures, Research and Development (R&D) lie at the core of its growth strategies. The acquisition of Fitbit was completed in 2021. Fitbit produces smartwatches and fitness tracking wearables.

Sundar Pichai took over as chief executive officer following the resignation of Larry Page in December 2019. The eleven-man board of directors of ALPHABET is chaired by John L. Hennessy.

Investment Thesis
The company derives revenue from Google and non-Google products. Google products include Google Search, YouTube, Google Play, Gmail and Google Maps. Non-Google products generate revenue from R&D, TV and internet services. Google produced, on average, 99.5% of top-line in the past eight years. Though they have contributed less than 1% of total revenue, non-Google products produced a revenue of $657 million in 2020. They are expected to contribute more to revenue going forward.

Advertising revenue remains the major source of earnings, generating over 80% of total revenue. The company makes money from online advertisements placed on properties such as Google Search, YouTube, Google Play, Gmail, Google Maps and Google Network Members’ properties.  Efforts are being made by the company to grow other sources of revenue such as its subscription-based products. The subscription-based products include G-Suite, cloud computing services and You Tube TV subscriptions. It is worthy of note that non-advertising revenue as a percentage of total revenue has been on the rise. In 2013, non-advertising revenue was 8% of total revenue but it has jumped to 19.5% in 2020. Google Cloud has generated a total revenue of $31.9 billion between 2017 and 2020.

The acquisition of You Tube in 2006 was a plus for management. With over 1 billion active users per month, You Tube allows people to share videos online. You Tube has been contributing to advertising sales and TV subscription sales. Google search engine is the most popular search engine allowing Google to display advertisements to billions of users. Both You Tube and Google Search are dominating the market allowing ALPHABET to make billions of dollars in advertising revenue every year. Google search properties produced 70.8% of advertising revenue and 57% of total revenue in 2020. Google advertising revenue has grown at a compound rate of 15.4% over the past three years. Adverting revenue in 2020 was $146.9 billion compared to $134.8 billion in previous year. Advertising revenue from the You Tube Platform increased from $15.1 billion to $19.8 billion in a year.

ALPHABET expends a considerable amount on R & D (about 15.2% of total revenue every year) due to the nature of its businesses. The company does not pay dividends to shareholders but continue to invest in its core (Google) and non-core areas in a bid to grow the company. However, investment may not yield fruits as some projects may not become commercially viable. For instance, it decided to close down Loon this year, 2021. Loon provides internet access, by way of internet-connected balloons positioned in the atmosphere, to underserved areas of the world.

We expect investors to benefit from owning the shares of ALPHABET. It has an edge in online advertising which turned over $146.9 billion in 2020. Revenue from cloud computing services has been on the rise. ALPHABET  stocks, in our opinion, offer enormous potential for capital appreciation.

ALPHABET has traded, on the average, 31.2x earnings, 4.3x book value and 6.1x sales. A share of the company is estimated at a value ranging from $1,932 to $2,348.1.  We expect a return of 12.6% from holding a share of the company.

Financial Overview
ALPHABET’s revenue of $182.5 billion in 2020 amounted to a 12.8% rise compared to 18.3% increase of the prior year. 46.6% of total revenue come from The United States while revenue from all geographical areas is increasing.  Google advertising produced $146.9 billion or 80.5% of   the total revenue (2019: $134.8 billion or 83.3% of total revenue). Advertising sales is growing, it has grown by 15.4% over the past three years. A bulk of the advertising revenue (84.3%) came from Google properties such as Search and You Tube. The You Tube Platform raked in advertising revenue of $19.8 billion in the current year, having grown by 30.5% year-on-year. Revenue from Search and other Google Properties was $104.1 billion, compared to $98.1 billion achieved in the previous financial year. Advertising revenue from Google Network Member’ Properties also grew 15.7% to $23.1 billion. Less than 1% of total revenue is attributable to non-Google products.

Gross profit hit $97.8 billion; it added 8.7% in a year. Growth in operating income surpassed the average of 15.3% by 5.1%. Operating income stood at $41.2 billion in 2020, up by 20.4% from $34.2 billion posted in 2019. Income before taxes increased 21.3% year-on-year to $48.1 billion at the end of 2020 financial year. In the same vein, net income grew to $40.3 billion from $34.3 billion.

Operating income margin gained only 144 basis points due to a marginal decrease in total expenses to turnover ratio. Pre-tax income margin of 26.3% surpassed the 8-year average by 0.3 percentage point. Net income to turnover ratio gained 0.8% to close at 22.1% in the year under review. Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) margin of 30.1% was a 1.7% improvement on the previous period’s figure. ALPHABET’s returns for 2020 were the highest in 6 years; Return on Average Equity (RoAE) and Return on Average Assets (RoAA) were 19.9% and 14.2% respectively.

The company had offset its short-term debt but long-term debt jumped to $13.9 billion in 2020 ($4.6 billion in 2019). However, total debt accounted for 4.4% of total assets and 6.3% of stockholders’ equity. ALPHABET makes tons of cash and is liquid; current ratio and acid test ratio stood at 3.1x each. The liquid assets of $136.7 billion was tantamount to 42.8% of total assets (2019: $119.7 billion or 43.4% of total assets). The company produces ample operating income and cashflow to settle its maturing obligations.

Though ALPHABET does not pay dividends to shareholders, total assets and shareholders’ equity have been growing. Total assets and shareholders have been increasing at 17.5% and 13.4% respectively over the past three years. Earnings Per Share (EPS) of $61.89 represented a 3-Year Compound Annual Growth Rate (CAGR) of 45% while Book Value Per Share (BVPS)  of $326.88 was an expansion of 14.1% over the past three years.

Business Risk
Online advertising is becoming increasingly competitive. Besides, non-Google products are subject to high risk. We are of the opinion that continuous spending on technology, coupled with intense competition, could exert downward pressure on profit margins going forward.

Recommendation: Buy

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