Alphabet (NASDAQ:GOOG) continued to grow at a blistering pace in 2017, remarkable for a company of Alphabet’s size. Revenue rose 23% over the prior year, while operating income before exceptional items rose by 22%.This growth was largely driven by a continuing shift to mobile search, a phenomenon which has proven to be highly accretive to Alphabet’s financial results over the past several years. YouTube viewership growth was another highlight of 2017, outpacing the company’s overall growth rate.
Over the past five years, Alphabet has grown its core earnings more than four times faster than the average S&P 500 company, and the tailwinds driving that growth remain in place today. In light of the company’s rapid growth, dominant position, and exceptional management, we believe Alphabet merits a large valuation premium to the S&P 500 Index. Yet after accounting for excess cash and startup losses, we find that Alphabet garnered a very modest premium to the index for most of the year. At the end of the third quarter, we added to our already substantial position in Alphabet at a price of $921 per share, making it the second largest holding in Sequoia’s portfolio behind Berkshire Hathaway. We believe our purchase price amounted to less than 20x expected core earnings in 2018, a clear bargain for one of the world’s best businesses.
With great success comes great scrutiny. The European Competition Commission levied a €2.42 billion fine against Alphabet in the third quarter of 2017 for allegedly promoting its own price comparison service over those of competitors. The company is appealing the fine and the amount is manageable for a company of Alphabet’s size – it amounts to about nine days of revenue. However, we perceive a rising tide of antitrust sentiment among both regulators and the public globally. We expect the regulatory environment to grow more difficult for Alphabet and its mega-cap technology peers as time passes. We consider this a natural consequence of the company’s dominant worldwide position. We do not believe it constitutes a serious threat to the health of the business, which continues to provide immeasurable value to consumers, gratis.
From Ruane Cunniff (Trades, Portfolio)'s Sequoia Fund 4th Quarter 2017 Manager's Commentary.
