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Thesis:
Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) is coming off its strongest year in FY21 along many other ecommerce giants. Revenue, earnings, and free cash flow all came in at record highs. Many believe these figures were only achieved because of the Covid-19 pandemic, as many business owners and consumers had to transition to online sales and purchases. However, Alphabet’s market share and presence are undeniably massive, nearly monopolistic. The cloud and digital advertising markets have crushed forecasts and are growing at exceptionally high rates, and Alphabet has continued to produce impressive results. Market growth and Alphabet’s track record of success are the reasons I believe the stock is still a buy.
(Note: All financial data is sourced from ycharts.com.)
Digital advertising growth is robust, and Alphabet is poised to capitalize on it:
According to data I could find on Statista, the global digital ad spend for FY22 was projected to be in the ball park of $524 billion. I haven’t found definitive figures on FY22’s global digital ad spend figures, so I will use Statista’s estimate as a base. Alphabet’s FY22 advertising revenues came in at $209.497 billion. This would give Alphabet a global digital advertising market share of 39.98%. To be conservative I will say Alphabet’s global market share is closer to 35%.
According to globenewswire.com, global digital ad spend in FY20 came in at $374.2 billion and is expected to grow at a CAGR of roughly 15.3% through FY25 and 13.7% from FY25 to FY30. I will use this data to calculate growth figures because FY20 data isn’t an estimate and is more conservative than Statista’s forecasts. By doing this I am forecasting using a more conservative market share figure from Statista forecasts and a more conservative base growth figure from globenewswire.com. In short, this method is the most conservative, deriving figures that could be reasonably achieved by Alphabet.
The data from globenewswire.com would give us a 10-year CAGR of roughly 14.5%, valuing the global digital advertising market at $1.45 trillion by FY30. Should Alphabet maintain a market share of 35%, it could generate roughly $507.25 billion in advertising revenue in FY30 so long as forecasts are accurate. It’s worth noting that global digital advertising forecasts have been short of what the market has produced, thus, these figures are not unreasonable. It’s also worth noting that Alphabet’s Google search engine facilitates over 5 billion searches per day, accounting for over 90% of the global search engine market.
The Wall Street Journal noted that digital advertising will account for 64.4% of all advertising in FY21, up from 60.5% in FY20 and 52.1% in FY19. This data shows that digital advertising is consuming all forms of advertising at a CAGR of 11.18%. At this rate digital advertising would hypothetically be the only form of advertising before the end of FY26. There will obviously always be other forms of advertisement, however, this data clearly shows the trajectory that digital advertising growth is on across the globe.
The growth observed in the digital advertising market leads me to believe that Alphabet’s FY21 results are sustainable. I do believe the Covid-19 pandemic got the ball rolling, but I don’t see the ball hitting a brick wall. While some pullbacks in revenue may occur in FY22, the general direction of the digital advertising market is very promising for Alphabet. It’s worth noting that Alphabet’s digital advertising revenue accounts for 81.31% of the company’s total revenue stream.
Alphabet’s cloud revenue has abundant upside potential:
According to data I’ve found, the global cloud market came in at $445.3 billion in FY21. When searching Alphabet’s cloud market share, I found figures around 8%, however, according to Alphabet’s 10k the company produced cloud revenue of $19.206 billion in FY21. This would give Alphabet a global cloud market share of 4.31%. While Alphabet is behind the likes of Microsoft’s Azure and Amazon’s AWS, the company is producing impressive growth in cloud revenue. Alphabet’s FY21 cloud revenue is up 47% from FY20. The global cloud market is expected to grow at a CAGR of 16.3% from FY21 to FY26, indicating the global cloud market should be roughly $947.3 billion by FY26. The takeaway here is that the global cloud market is growing rapidly, and Alphabet’s cloud revenue is growing even quicker.
I am forecasting that Alphabet achieves a CAGR of 30% between now and FY26 in cloud revenue. I don’t think that level of growth is unreasonable based on the respective growth rates seen in the global cloud market and Alphabet’s cloud revenue growth seen in FY21. This would give Alphabet FY26 cloud revenue of approximately $71.31 billion. This would represent a global cloud market share of roughly 7.5%. Again, I think these figures are quite reasonable, especially considering they represent a market share of less than 10%.
I would also like to address a personal belief that the cloud market has exceptional room for growth that is likely not being accounted for. I will use autonomous cars as a single example. According to Bloomberg, autonomous cars will generate as much as 40 terabytes of data an hour via radar, censors, and cameras. This would be the equivalent of an iPhone’s use over 3,000 years. As the world continues to transition to digital storage and autonomy, cloud service providers have overwhelming potential. Is it worth mentioning that Alphabet is currently the third largest cloud provider in the world?
Alphabet’s moat and competitive edge in the digital advertising and cloud markets:
Alphabet’s Google search engine is the company’s moat. As mentioned previously, Google facilitates over 5.4 billion searches per day with roughly 250 million U.S. visitors per day. Google is the heart and soul of the internet. When people need to look anything up on the web, they start with Google. Bing is considered the second largest search engine in the world with 900 million searches per day, less than 20% of Google’s usage. Mozilla Firefox has been known to be a popular web browser; however, platform has been shedding users. In 2018 the Firefox had roughly 244 million users. As of 2021 the engine has 198 million users, representing a 20% loss in its user base in three years. Google controls over 90% of the global search engine market with little competition in sight. When you think of ketchup you think Heinz, cola is Coke, and internet is Google. I would argue that Alphabet’s moat in Google is the largest in the market.
This leads me to Alphabet’s edge in the digital advertising market. What makes digital advertising so appealing is the ability to reach millions of people that wouldn’t be possible via traditional advertising methods. Facebook and Amazon are said to be Google’s biggest competitors in the digital advertising market. Facebook currently has 2.91 billion active users, while Amazon sees roughly 74 million visitors per day. When it comes to Facebook, it’s not clear how many users are using the platform daily. Even if the figure came in at 2.5 billion, it’s still half the exposure that Google gets. Amazon’s 74 million visitors per day is a mere 1.4% of Google’s 5.4 billion. From a personal standpoint, I have never purchased anything from a Facebook advertisement. I have found promoted cites on Google that I ended up purchasing products from. Google caters its results directly to what a user is searching for. Facebook and Amazon will advertise based on mined data to cater to the perceived wants of its users. The difference is Google doesn’t have to guess what you want because you just told it what you wanted. Google holds the competitive edge with usership and the nature of how advertisements are utilized. In short, Alphabet’s ability to maintain a market share of 35% in the digital advertising market is more than reasonable.
While Alphabet appears behind the curve in the cloud market, I think there’s more than meets the eye. Google developed Kubernetes technology that allows the running of containerized applications easily across cloud infrastructure. This technology allows users to run applications on various clouds, from AWS to Azure. Alphabet also has BigQuery Omni powered by Anthos, which analyzes cloud data. Better yet, this data can be analyzed in Google cloud, AWS, or Azure. Essentially, Alphabet is creating open cloud tech usable across different cloud providers. This means corporations can run BigQuery in Amazon or Azure alongside existing data and applications. Alphabet is taking an open and interconnected approach to the cloud market. By doing this cloud users won’t feel tied to a single cloud provider. This will be particularly appealing for large corporations with massive amounts of cloud data. Alphabet has received criticisms in the past for not being diligent in its cloud offerings to enterprise customers. However, Alphabet’s open-source approach gives it potential to reach customers that are already tied to AWS and Azure. This is because AWS and Azure customers won’t have to migrate their entire cloud portfolios to Google cloud, they will be able to use Google cloud services like BigQuery in tandem with their existing cloud provider. Alphabet’s open approach to the cloud market is the reason I believe the company will be able to grow cloud revenues at a CAGR of 30% or more through FY26.
Alphabet’s largest risks are associated with monopolism:
Regardless of economic downturns or rising inflation, Alphabet’s business model and overall macro-outlook is promising. I find the biggest risk to Alphabet’s long-term success to be issues regarding the company’s monopolistic practices. Alphabet was sued by the U.S. department of justice in 2020 for violating antitrust laws. The last time a tech company was sued for violating antitrust laws was Microsoft in 1998. Congress has held hearings to discuss whether Alphabet needs to be limited or broken up. Apple, Amazon, and Meta are also the department of justice’s radar regarding monopoly power. Should the department of justice choose to split up or limit Alphabet, things could get very messy for shareholders. I will be keeping a close eye on digital advertising and cloud revenue growth. While it appears from a consumer and federal standpoint that Alphabet’s business is dominant to the point of monopoly, competition is present. Monitoring antitrust lawsuits against Alphabet is particularly imperative, as I believe the DOJ is likely the biggest risk Alphabet and its shareholders face. There doesn’t appear to be any other significant risks for Alphabet as long as revenue growth continues and government interference does not occur.
Is Alphabet stock overvalued at current price levels?
Alphabet doesn’t appear to be overvalued at current prices, especially considering the observed growth in the markets it services. In my forecasts for the digital advertising and cloud markets I came up with FY30 digital advertising revenue of $507.25 billion and FY26 cloud revenue of $71.31 billion. If we scale back estimates for digital advertising revenue to FY26, we get a forecasted figure of $295.12 billion. This would give Alphabet a forecasted FY26 revenue of $366.43 billion not accounting for other bets or hedging, two revenue figures also listed under total revenues. With Alphabet’s profit margin of 29.51%, this would indicate a FY26 net income of $108.13 billion and EPS of $163.59. With Alphabet sitting at roughly $2,612 per share, we’d be looking at a forward P/E ratio of 15.96. Free cash flows for Alphabet grew at a higher rate between FY20 and FY21 than revenue and earnings. Alphabet’s current P/E is roughly 23 and P/FCF is roughly 26. Considering free cash flow growth is outpacing revenue and earnings growth, we can hypothesize that FY26’s P/FCF ratio will be relatively close to the FY26 P/E forecast of 15.96. I’d like to mention that the above forecast is quite conservative. I’ll quickly lay out the YoY growth in revenue, net income, earnings, and free cash flow per share to clarify.
- FY21 revenue came in at $257.64 billion, up 41.15% from FY20.
- FY21 net income came in at $76.03 billion, up 88.8% from FY20.
- FY21 EPS came in at $112.20, up 91.43% from FY20.
- FY21 free cash flow per share came in at $98.89, up 58.57% from FY20.
My digital advertising revenue forecasts are derived from market growth rates relative to market share. My cloud revenue forecasts are derived from reduced growth rates relative to market growth and share. My point is that conservative forecasts point to Alphabet trading at a forward P/E of 15.96. Alphabet’s average P/E ratio over the last ten years is 28.5. If Alphabet can trade around its 10-year P/E average, shares will be worth $4,662 in FY26 according to the forecast above. For these reasons I believe Alphabet is valued fairly and still worth buying at current prices.
I also want to point out some figures from Alphabet’s balance sheet to show how financially secure Alphabet is.
- FY21 debt-to-equity ratio sits at 0.051.
- FY21 shareholder equity came in at $251.64 billion.
- FY21 cash on hand sits at $139.65 billion.
- FY21 retained earnings came in at $191.48 billion.
In short, Alphabet’s balance sheet is as strong as they come. Two other metrics I’d like to note are cash flows from investing and return on invested capital (ROIC). Alphabet’s FY21 cash flow from investing came in at ($35.52) billion, up 10% from FY20. Meanwhile, ROIC for FY21 came in at 30.42% while weighted average cost of capital (WACC) sits at 8.74%. Alphabet is investing heavily in growth and generating returns over 20%.
Alphabet has also declared a 20-1 stock split to take place on July 1st, 2022. I believe this could entice more investors to dive into the stock, as shares would be priced at $130 per share if the stock split today.
Conclusion:
In conclusion, Alphabet stock appears to be a buy at current prices. The stock is down roughly 14% from highs just north of $3,000 per share. Alphabet is first in the digital advertising market and third in the cloud market; both markets forecasting massive growth for the foreseeable future. Using conservative forecasts Alphabet is trading at a forward P/E ratio of 15.96 with a 10-year average P/E ratio of 28.5. Alphabet still has plenty of room for growth, is a leader in the markets is services, and is trading at reasonable prices. The company is financially stable and operationally efficient. I also believe the stock split in July will draw more attention from investors as shares will be trading at 1/20th the price before the split. In short, Alphabet still has plenty of room for growth, is reasonably valued, and still a buy at current price levels.
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