In addition to being omnipresent in the online search world, Google (GOOG, Financial) has found another way of being useful in an individual's daily life. Early last month, the tech giant launched the Google Home product with aims to serve as a voice-activated speaker powered by the company’s Google Assistant.
Recently, Google Home also added a few more actions into its home assistant’s arsenal.
(Google)
Earnings performance
On Oct. 27, Alphabet delivered its third quarter fiscal 2016 results. The tech giant delivered strong 19.7% sales growth to $64.2 billion and 23.8% profit growth to $14.1 billion nine months into its fiscal 2016 operations. This an amazing level of profitability considering that Alphabet’s operational expenses grew by 18.8% in the period.
“We had a great third quarter, with 20% revenue growth year on year, and 23% on a constant currency basis. Mobile search and video are powering our core advertising business and we’re excited about the progress of newer businesses in Google and Other Bets,” said Ruth Porat, CFO of Alphabet.
Alphabet’s shares remained almost flat, or 0.27% the following day, while the broader Standard & Poor 500 index closed down by 0.31%.
Valuations
According to GuruFocus data, Alphabet’s class A shares had a trailing 12-month PE ratio of 29.6 times (higher than 50% of its peers), PB ratio of 4 times (lower than 61% of its peers) and PS ratio of 6.59 times (lower than 79% of its peers). The company does not provide dividends.
Market performance
Alphabet underperformed the market year-to-date with 4% versus 12.8%. Meanwhile, the company’s class A shares outperformed the market with 17% total return versus 15.56% on a five-year total return basis.
Alphabet
Alphabet was founded in October 2015 and serves as a parent company of Google. In its filing, Alphabet is a collection of businesses, of which the largest is Google. The company also includes businesses that combine as Other Bets, such as the Verily, Calico, X, Nest, GV, Google Capital and Access/Google Fiber.
Alphabet generates its revenues mostly by delivering cost-effective and relevant online advertising to its consumers. Alphabet generated 90%, or $67 billion, of its total Google segment revenues from advertising in fiscal 2015.
Alphabet derived most of its business from the U.S., at 46% of the company’s total 2015 sales. Google's core products such as Search, Android, Maps, Chrome, YouTube, Google Play and Gmail each have over one billion monthly active users. These core business operations by Alphabet are immensely admirable as it could possibly produce a bottomless cash flow.
(Research and development expenditures, 10-K and 10-Q)
Alphabet, nonetheless, guarantees its shareholders that it will not become complacent and rest on its laurels. The company dedicates a huge amount of its sales in research and development expenditures alone, $12.3 billion or 16% of its gross sales in fiscal 2015.
Alphabet has two reported segments: Google and Other Bets.
(10-Q and 10-K)
The Google segment includes Alphabet’s main internet products such as Search, Ads, Commerce, Maps, YouTube, Apps, Cloud, Android, Chrome and Google Play. The Google segment also includes hardware products the company sells, such as Chromecast, Chromebooks, Nexus and the recently launched Virtual Reality products.
In 2015, the Google segment grew 13.5% to $74.5 billion and delivered an operating margin of 31.4%. Nine months into fiscal 2016, the segment grew 19.3% year-on-year and had remarkably the same margin as the previous year.
Other Bets
According to Alphabet, the Other Bets segment is a combination of multiple operating segments that are not individually material. Other Bets includes businesses such as Access/Google Fiber, Calico, Nest, Verily, GV, Google Capital, X and other initiatives.
In 2015, Other Bets segment grew 37% to $448 million and delivered an operating loss of $3.57 billion,Ă‚ markedly several times greater than the revenue it generated. Nine months into fiscal 2016, the segment grew 85.4% and delivered an operating loss of $2.5 billion, compared to $2.25 billion the year before.
Overall, Alphabet had five-year sales and profit growth averages of 20.7% and 13.96%, respectively.
Ownership
Alphabet has three different classes of shares, class A, B and C. The company’s class A common stock, or ticker GOOGL, has one vote per share, class B common stock has 10 votes per share, and class C capital stock, ticker GOOG, has no voting rights.
As of December 2015, Google founders Larry Page and Sergey Brin, and Alphabet executive chairman Eric Schmidt owned approximately 92.5% of Alphabet’s outstanding Class B common stock, which translated into a 58.5% combined voting power in the company.
(CNN Money)
As observed, there has been a minimal deviation in either the class A or class C share price over time.
Cash, debt and book value
As of Sept. 30, Alphabet had $83 billion in cash and $3.9 billion in debt, indicating a debt-equity ratio of 0.03. Alphabet also had 12% of its $159.9 billion assets in goodwill and intangibles with a book value of $134.1 billion, compared to $120.3 billion in December 2015.
Cash flow
(10-Q)
Alphabet also achieved a 33.4% cash flow from operations growth to $26.6 billion in its recent nine months of operations. Though brought mostly by its incredible profit growth, the company had a 27.7% increase in depreciation and impairment of its property and 28.9% increase in stock-based compensation expense. Also, Alphabet had a 97% increase in its income taxes cash flow.
Capital expenditures for the online search giant were $7.1 billion, leaving the company with $19.5 billion in free cash flow, compared to $12.1 billion last year.
(10-Q and 10-K filings)
In October 2015, Alphabet initiated a $5 billion share repurchase program. The repurchase program ended in June 2016 with 5.2 million Alphabet class C repurchased amounting to $3.7 billion, or 18.9% of its free cash flow in the recent nine months of operations.
In October 2016, Alphabet again decided to perform another share repurchase program, this time with a $7 billion target.
In addition to the recent buyback activities, Alphabet has been consistently able to allocate huge amounts of cash flow in marketable securities. In the most recent nine months, the company placed $71 billion of its cash flow in assets. Alphabet had about 44%, or $32.4 billion, invested in the U.S. Government notes; 17.1% invested in agency mortgage-backed securities and 20.5% invested in corporate debt securities.
The company also had a positive $54.4 billion in maturities and sales of its marketable securities for the period compared to $46.9 billion last year.
Conclusion
Some months ago, I completely ignored Google secondary to its valuations without even trying to understand its business. This time around, I have gotten to know the company better and the company does deserve some market (price) appreciation brought by its compelling visionary qualities and the established business model to produce the money to support these ideas.
Articles describing how most dollar advertising spent online are earned by just both Google and Facebook (FB, Financial) only describes how both companies have developed such moats overtime. Facebook was founded in 2004, while Google was founded in 1998.
There is no doubt that Alphabet wants to return most of its bountiful cash flow to its shareholders by its recent share repurchase programs.
(Google Finance)
Analysts at Mizuho and RBC Capital Mkts both ranked Alphabet’s shares as a buy and outperform, respectively, and see a target price of $1,025 per share.
Having Alphabet’s share price touch new highs in recent months, it would probably be safe to say that the company’s shares are a speculative buy with at least a $1,000 share price target.
--
Google is the third of the four companies in the widely known FANG stocks I have reviewed. Here are the previous articles:
Published on Dec. 8, 2016: Facebook Is a Pass.
Published on Nov. 14, 2016: Amazon Is a Speculative Buy”‹.
Disclosure: I do not have shares in any of the companies mentioned.
Start a free seven-day trial of Premium Membership to GuruFocus.Ă‚
