FAANG stocks like the Alphabet share were and still seem to be a guarantee of substantial price gains. You would have achieved 20 percent price gain per year with the Google Company since 2004. Alphabet does not quite come close to a price rocket like Amazon with more than 30 percent price gain per year, but it is still one of the stocks whose IPO one would have liked to have been part of.
After years of price increases, the question arises whether the Alphabet share is still a buy. To help you make the decision, let’s take a look at the company’s long-term earnings growth and the looming dangers that could put an end to rising earnings. And of course we explicitly deal with the valuation of the Alphabet share. Because even quality stocks can be overvalued.
How does Alphabet earn money?
Alphabet divides its business into the two segments “Google” and “Other Bets”.
The “Google” segment – a general store
The “Google” segment comprises the established and often well-known core products of the alphabet. This includes in particular the omnipresent Google search, the navigation service Google Maps and the YouTube platform, all of which generate sales through advertising. Apart from advertising, Alphabet continues to earn money with the Google Cloud and the “Google Play” app store. The Android operating system for smartphones and tablets, on the other hand, does not generate any direct sales. In addition, Alphabet develops and sells hardware such as the Pixelbook (laptop) or Pixel smartphones as well as products for the networked home from the Google Nest family (cameras, doorbells, smart speakers). The Google segment is like a general store with a wide range of services and products made from software and hardware.
It is important to know that Alphabet makes advertising with 83 percent of the Group’s sales. The Google Cloud contributes 6 percent to sales and 11 percent comes from fees from app sales, premium memberships or hardware sold.
Despite the key page towards advertising, Alphabet is interesting because many of its products occupy leading positions in the market. Your search engine has a global market share of over 90 percent. Alphabet also dominates the market for mobile operating systems with Android and has a market share of almost 75 percent. Android does not generate direct sales, but Android serves as a platform for paid services such as the Play Store. Mobile phone manufacturers also pay moneyto install Google software like the so-called Google Mobile Services on their devices. Without the market-leading position of Android, these sales would not exist.
Advertising sales increase annually by around 20 percent. In contrast, Alphabet’s cloud sales increased by a whopping 52 percent in 2019. Nevertheless, Alphabet is behind the absolute market leaders Amazon in the cloud business and Microsoft “Only” the number three worldwide. Given the strength of Amazon and Microsoft, Alphabet seems unlikely to outstrip its major competitors in the cloud business.
The “Other Bets” segment – the start-up incubator
The “Other Bets” segment is Alphabet’s experimental laboratory. Here start-ups are managed as subsidiaries, the turnover of which hardly plays a role, but which could be “the next big thing” in the future, which means “Moonshot” in German. In around 90 percent of cases However, a start-up is a total failure and it can be assumed that the situation is similar with Alphabet. In fact, the Other Bets segment is a notorious loser. In 2019, a loss of $ 4.824 billion was earned on sales of $ 659 million.
Nevertheless, the bet on the “next big thing” makes sense. Because how is it so well up front in the annual report:
Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary.
In order not to rest and rust, money is taken in hand to try out promising concepts in practice on paper. Examples of this are the Personal-Financial.comG investment vehicle, the research and development company Calico, the company Access, which uses Google Fiber in the United States establishes and provides fiber optic connections, the research institute Verily, Waymo as a developer for autonomous robotic vehicles and the semi-secret daughter with the mysterious name Xwho, as a former Google research unit, is looking for ideas for further potential “moonshots”.
Alphabet’s dependence on advertising
Alphabet, like Facebook, is trying to expand its sources of revenue with the help of a growing product portfolio in order to solve its dependency on the advertising business. In this effort, Alphabet has an ace up its sleeve with the fast-growing Google cloud business. Cloud sales are currently increasing by 50 percent, while advertising revenues are “only” increasing by just under 20 percent. I assume that the cloud computing market will continue to grow rapidly. In this respect, Alphabet only has to maintain its market share in order for the advertising business to reduce its share of total group sales.
|Market capitalization||€ 885.2 billion|
|Stability gain||0.96 of max. 1.0|
No ace yet, but Alphabet has definitely a lot of cards in his hand through the “Other bets”. Health services (health care market) are a promising business area. Here is Alphabet with its start-up daughters Calico and Verily strongly represented in research and development. Calico is looking for ways to stop the natural aging process. Verily is much broader. Here research is carried out in parallel in several directions. The company is looking for ways to make better use of data in order to treat diseases faster and more effectively. In addition, it has developed a spoon, which makes it easier for patients with tremors to eat. I assume that Alphabet will be more aggressive in the fast growing health care market in the future will position. The proposed merger of Alphabet and Fitbit fits this. In November 2019, Alphabet and Fitbit entered into an agreement that Alphabet will acquire Fitbit for $ 2.1 billion and will be integrated into the “Google” segment. Fitbit is a manufacturer of so-called fitness trackers. These are mainly worn on the arm like a watch and offer users the opportunity to record their training sessions and track their successes. Depending on the model, the trackers record extensive data. The company can not only count steps, but also record other parameters such as heart rate and sleep quality. With the acquisition, Alphabet will have access to important patient data and a well-known brand that can serve as the core for the development of further health services. Apple took a similar approach with the Apple Watch.
Is the COVID virus at risk?
Alphabet has grown a lot in recent years. It has not only increased in sales, but also in profits, which shows that the company is profitable. The stock finder shows you that the corona pandemic has not left its mark on Alphabet’s sales performance. The advertising business was particularly hard hit in March. Nevertheless, Alphabet was able to grow by a strong 13 percent in the first quarter and build on the sales development of previous years.
January and February, which were not affected by Corona, and the increasingly noticeable diversification of the portfolio were responsible for the stronger than expected growth. Especially the cloud With its growth, it was able to cushion the decline in sales due to corona. You can see from the price trend that the market sees today’s alphabet much better positioned than during the 2008 financial crisis. At that time, the share price collapsed by over 60 percent, while the price losses during the corona crash were only half as high and were already made up again after a few months. However, the corona crisis is far from over. In the first quarter of 2020, only one month was significantly affected by the effects of the corona pandemic. Should the advertising revenue collapse over a longer period of time, this would result in significant losses in sales and profits. CEO Sundar Pichai therefore rightly looks to the near future with caution.
In this respect, earnings and cash flow are likely to decline in 2020 as a whole and only increase again in the following years, provided that the corona crisis is over. Despite the headwind, Alphabet is and remains highly profitable. The historical profit trend is impressive. Earnings per share rose from $ 0.73 in 2004 to just under $ 50 in 2019.
A downside, however, is the development of margins. High investments and the lossy “Other Bets” segment drain on the profit margin. In addition, many business areas such as YouTube are inherently less profitable than traditional advertising business with the Google search engine. I do not expect Alphabet’s margins to increase again in the medium term, but instead level off at the current level.
Is the Alphabet share fairly valued?
As already mentioned, the Alphabet share performed extremely well despite the negative impact on the advertising and advertising market. As a result, the current share price again shows a significant overvaluation. It is almost irrelevant what time period we are in the dynamic stock valuation look at. Based on the historical profit and cash flow figures, there is always a short-term setback potential of over 20 percent at the current fair value. It is not until the end of next year or early 2022, if the share stagnates, that the operating business should catch up with the airy valuation and bring the share back into the fair range.
Don’t worry about Alphabet’s finances, on the other hand. At 25.51 percent, the debt ratio is not only very low, Alphabet also sits on a huge mountain of cash in excess of $ 117 billion. It could trigger a cash flow that would sweep away all of the $ 70 billion in debt in one swing.
Is Alphabet the next candidate for unbundling?
With regard to an impending split, Alphabet is exposed to the same dangers as Amazon, for example and Facebook, whose chairman attended a hearing in the US Congress that deal with potential market abuse in different ways. Because, as befits a FANG share, Alphabet is also under general suspicion for market abuse and has so far been able to pay the European Commission more fines than any other company for antitrust violations. In addition, the twitter-happy US President Has criticized the company and its strong market position several times and pondered the consequences out loud. Regardless of this criticism, it is worth knowing that the Alphabet subsidiaries are already operating independently. In the worst case, a split-up with a business model that is already viable could continue to exist successfully on the market. This doesn’t even have to be a disadvantage for investors, as you can see, for example, from the very successful development of the former eBay subsidiary Paypal.
The latest figures: advertising sales collapse by 8 percent
According to the latest Q2 2020 figures advertising revenue fell 8 percent. Due to the corona pandemic, many companies have cut their advertising budget for the Google search engine. Facebook published its quarterly figures in parallel to Alphabet. Facebook also makes the majority of its sales with advertising. The two companies together share over half of the advertising budget in the United States. However, while Alphabet’s advertising revenue fell 8 percent, Facebook’s advertising revenue increased 10 percent over the same period. Advertising via social channels such as Facebook or Instagram seems to be doing much better in the current crisis than advertising via a rather impersonal search engine like Google.
Aside from advertising, Alphabet was able to increase sales with the Google Cloud “as usual” by almost 50 percent, while “Other Bets” sales were down by $ 14 million compared to the same quarter last year, with losses falling by 127 million despite the lower sales USD rose to USD 1.1 billion. In our view, Alphabet did not have a good quarter overall.
Conclusion: The Alphabet share is not a purchase for us
The Alphabet share continues to benefit from the absolute dominance of the Google search engine in the western world, which is expected to continue in the coming years and will guarantee a reliable cash flow. Alphabet continues to benefit from the strong cloud business, maintains and maintains several promising subsidiaries and can draw on the cash reserves at any time to buy external growth and digest possible failures in the “other bets”. So it doesn’t have to spark every start-up bet to keep Alphabet up.
However, the corona virus currently has a braking effect on advertising sales and remains an uncertainty factor as long as it affects the global economy. You may also be burdened by the high valuation of the Alphabet share and the risk of further antitrust measures such as fines or even a breakup. Due to the high valuation of the Alphabet share and the vulnerability of the advertising business in the Corona crisis, we currently advise against buying the Alphabet share.
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