There are only a handful of companies in the world that can argue they have power approaching Alphabet (ticker: GOOG, GOOGL). And ever since its initial public offering in 2004, GOOG stock has performed accordingly.
But 17 years after its initial public offering, the world’s leading search engine isn’t the growth dynamo it once was, and government scrutiny has led to a major antitrust lawsuit that threatens the very core of Alphabet’s business.
In fact, as popular consumer tech products evolve, it has become an open question in Silicon Valley whether Alphabet is beginning to fall behind the times.
Here’s a brief overview of the Mountain View, California-based technology giant, its core areas of business, and — most importantly for prospective investors — the pros and cons that can help answer the question: “Should I buy Alphabet stock?”
— Alphabet stock at a glance.
— Pros of buying.
— Cons of buying.
— The bottom line: Should you buy Alphabet stock?
Alphabet Stock at a Glance
In 2015, Google restructured its business and reincorporated itself as Alphabet, a holding company whose major subsidiary would be Google, the world’s most dominant search company. Under the restructuring, investors were able to differentiate the results between the cash-cow Google and Alphabet’s money-losing “moonshot” investments in the “Other Bets” category.
Despite the separation, there’s a reason the company kept its ticker as GOOG: Alphabet is still essentially just a big proxy for its crown jewel, Google.
GOOG stock’s lifeblood is digital advertising, a massive industry that it dominates alongside its rival, Facebook ( FB) — the two companies control nearly 70% of the digital advertising market in the U.S. Google sells ads against its search results for specific terms, and also operates a sprawling ad network, placing ads on third-party sites for a cut of the resulting revenue.
With mobile slowly but surely overtaking desktop as the world’s preferred search platform, Google’s Android operating system has become ever more valuable; Android enjoys roughly 70% of global market share, and Google is the default search engine for Android — that’s simultaneously a key part of Alphabet’s business, and a key point in the U.S. government’s antitrust lawsuit.
But Alphabet’s main business segment, Google Services, isn’t just the search platform: YouTube, Gmail, Google Play, Pixel phones, Google Home smart speakers and the company’s expanding hardware business are a few of the big-name products supplementing Alphabet’s bottom line. In fact, given macroeconomic headwinds, these side businesses may soon become more important for Alphabet than ever.
One of Alphabet’s most important side businesses is Google Cloud. The cloud has recently become a battleground for the biggest names in tech, including Alphabet’s rivals Amazon.com ( AMZN) and Microsoft Corp. ( MSFT), and Alphabet clearly doesn’t want to let the competition get the upper hand. The company began to break out Google Cloud revenue a year ago, but in the fourth quarter of fiscal 2020, for the first time ever, it reported Cloud Services as a stand-alone segment of its business in its earnings report.
As for Other Bets, the segment accounted for an immaterial 0.3% of Alphabet’s overall revenue last quarter and lost a disproportionate amount of money doing so. The segment posted $196 million in revenue and an operating loss of $1.13 billion. This is where some of the wacky yet potentially huge long-term projects live, such as Google Fiber, the Waymo self-driving car unit, anti-aging research outfit Verily, and a drone delivery unit.
Pros to Buying GOOG Stock
2020 was a difficult year for many businesses, and the first thing companies do when money gets tight is cut their advertising budgets — that’s bad news for the biggest advertising platform in the world.
In fact, in the second quarter, Alphabet hit a roadblock that shareholders never thought they’d see: its first year-over-year decline in revenue. Alphabet reported $38.3 billion in revenue during the second quarter of 2020, down from $38.9 billion in the same quarter last year — not an enormous loss, but the fact that revenue dropped was a big red flag for investors.
But in the fourth quarter, the company bounced back better than ever thanks to a rebound in advertising revenue. Alphabet brought in $56.9 billion in revenue, an impressive 23% increase over the same quarter last year — made all the more impressive considering that revenue had risen 17% year over year in the fourth quarter of 2019. The vast majority of this quarter’s gain came from advertising revenue, which grew to $46.2 billion from $37.9 billion during the same period last year.
No matter what happens to advertising revenue, Google has firmly entrenched itself as the world’s go-to search site. The search giant controls more than 88% of the U.S. market and about 92% of the global market share. And for the time being, Android serves as a pretty good insurance policy against other search companies taking significant mobile share. But shareholders must be relieved that Google’s main business seems to be stabilizing.
The second pro to owning GOOG stock, aside from its big-time search engine cash cow and exceptional brand, is the company’s investment in diversification. Its portfolio of products ranges from self-driving cars and YouTube to and artificial intelligence and voice search.
YouTube is arguably at the epicenter of the consumer transition from traditional mass-market media to dispersed, on-demand and increasingly mobile media consumption — a transition that the pandemic has only accelerated. During the earnings call, management was thrilled to point out that more viewers are watching YouTube than ever before and for longer periods of time. In fact, according to Chief Business Officer Philipp Schindler, “YouTube reaches more 18 to 49-year-olds than all linear TV networks combined.”
These factors have made their way into Alphabet’s earnings report, with YouTube ad revenue increasing from $4.7 billion to $6.9 billion in the fourth quarter — an impressive 46% gain year over year. Shareholders should be particularly pleased about the success of direct-response ads on YouTube, a relatively new revenue stream for Alphabet that the company has quickly capitalized on. And while advertising revenue is Alphabet’s bread and butter, it doesn’t hurt that YouTube Music and YouTube Premium now have more than 30 million paid subscribers combined.
At this point, advertisers who aren’t shifting more of their budget to online video platforms are simply missing out.
Longer term, Google’s willingness to invest in bold new projects outside its core competency as a search engine could be precisely what allows it to continue as a growth stock despite hundreds of billions in annual revenue.
Several promising areas hold the type of game-changing potential that could launch a new era of growth for GOOG shareholders: in particular, artificial intelligence and autonomous vehicles, or AVs. Alphabet’s Waymo subsidiary is already a leader in AVs, and the company’s research and development investments in artificial intelligence have made it one of the best AI companies, too.
A line item dubbed “Google other,” which includes its Pixel mobile phones, Google Play and soon FitBit, enjoyed revenue growth of more than 26% in the fourth quarter to $6.67 billion. According to management, the Google Play app and game downloads were particularly strong as people stuck at home hopped on their phones to blow off steam, while non-advertising revenue from YouTube (i.e., subscriptions) contributed to the increase as well.
Cons to Buying GOOG Stock
Unfortunately, there’s nothing the company can do about the fact that Amazon exists — and is attacking the search giant on all fronts.
Amazon poses a number of risks for GOOG, including its encroachment into voice search — which might be the very future of search itself — where Amazon’s Alexa virtual assistant has a huge first-mover advantage over the Google Nest that it’s ruthlessly capitalized on. Amazon is also seizing digital advertising dollars, as marketers shift spending to Amazon’s growing platform and more lucrative product searches begin on Amazon than Google.
But perhaps the business where Amazon holds its strongest advantage over Google is in the cloud. Google’s biggest rivals long ago realized the importance of cloud computing, which has only grown since working from home became the new normal. These investments are beginning to reap impressive profits: Amazon Web Services is the clear market leader in terms of pure profit. AWS brought in $3.54 billion in operating income for Jeff Bezos and the gang in the fourth quarter, and $13.53 billion for the full year.
That leaves Google Cloud to play catch-up behind AWS and Microsoft’s Azure. It’s clear that Alphabet recognizes the importance of the cloud, given that it now breaks Google Cloud earnings out as its own distinct business segment — but it’s also clear from the numbers that Alphabet has a long way to go to supplant its competitors. In the fourth quarter, Google Cloud brought in $3.83 billion of revenue, but posted a loss of $1.24 billion. For the full year, Google Cloud’s net loss was $5.6 billion, an increase from the $4.65 billion loss in fiscal 2019 and the net loss of $4.35 in fiscal 2018.
It’s not all doom and gloom for Alphabet’s burgeoning cloud services. Google Cloud’s revenue rose 47% year over year, and management seems confident that it can catch up to the competition. Last year, Google Cloud was helped by the worldwide lockdowns as people were forced to work remotely. Millions of companies used Alphabet’s G Suite of services — such as Gmail, Drive, Chat and Meet — and millions more will continue to use those services as remote work becomes more normalized. But at this point in time, Alphabet is investing heavily in the cloud, and that investment is going to take time to pay off. Until then, the company will continue to post heavy losses.
Taken in concert, these trends don’t inspire much confidence in Alphabet’s ability to churn out company-changing profits anytime soon. Amazon beat Google to market by years in smart speakers and cloud computing, GOOG’s Pixel phone has thus far proven unable to dislodge Apple‘s ( AAPL) iPhone from its perch, and the company recently threw in the towel on its Stadia video game studio.
The biggest concern investors have regarding Google’s future is regulation.
In mid-2019, news broke that the Department of Justice had opened an antitrust inquiry into the company. Now that investigation has been completed, and the DOJ has decided to move forward with what will be one of the biggest and most closely followed antitrust lawsuits of all time.
The issues are twofold: mobile market share and advertising market share. The DOJ alleges that Alphabet pays massive amounts of money to Apple to keep Google the default search engine on devices powered by Apple’s iOS, preventing other search companies from gaining any market share. Meanwhile, Alphabet’s Android market share is massive, and the default search engine on Android devices is, of course, Google. The combination has given Alphabet an incredibly strong position in mobile search, and the DOJ has deemed these practices anticompetitive.
At the same time, the DOJ doesn’t like that Google handles just under 90% market share of U.S. search queries. This gives Alphabet a monopoly over the search advertising industry, and the DOJ alleges that Alphabet has used its dominance to give its own products priority in search results, among other issues.
As Big Tech comes under the regulation microscope, this lawsuit will be telling for how successful future litigation may be.
Finally, while GOOG stock certainly doesn’t appear grossly overvalued, shares do trade for more than 35 times earnings with no obvious catalyst on the horizon.
The Bottom Line: Should You Buy Alphabet Stock?
No stock is perfect, and Alphabet is no different. But the company does have an incredible competitive advantage in search and works hard to diversify its business for dynamic future growth.
There’s no other company in the world positioned the way Alphabet is, and that’s the most compelling fundamental reason to buy. Yes, Google is entering a new era where regulation could be a major overhang, but keep in mind Big Tech counterparts such as Apple, Facebook and Amazon are also under the microscope. But with its main business segment seeing strong growth and the economy beginning to find stable footing, Alphabet will be just fine.
If you’re holding for the long term and want to own one of the most compelling companies in tech, there’s nothing wrong with buying some GOOG shares now simply for peace of mind and adding more if it pulls back.
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