Alphabet (GOOG, Financial)'s business model is not standing still. The company is set to capitalize on growth in the artificial intelligence space through its autonomous driving unit. It is also ramping up its exposure to China, gradually expanding its operations in the world’s second-largest economy.
The company is a dominant force in the smart speaker market, where user data is being used to enhance its advertising business. And new product launches could be ahead as the company seeks to grow at a time when voice-activated search threatens its core advertising business.
Although the stock has risen 26% in the last year versus a 17% gain for the S&P 500, further outperformance could be ahead.
Evolving strategy
Artificial intelligence is expected to drive global GDP 14% higher by 2030. Alphabet could capitalize on this growth potential through its autonomous driving unit, Waymo. It is expected to launch a ride-hailing service in the coming months, which is set to add as many as 82,000 vehicles to its fleet in the coming years. Given that there are expected to be 33 million driverless vehicles sold annually by 2040, the segment could offer a high rate of growth. With the company having spent a year testing its Early Rider Program, revenue generation could be ahead in the near term.
Alphabet is also seeking to ramp-up its exposure to the increasingly lucrative Chinese market. It has apparently created a version of its Android app that has been reviewed by Chinese officials. It is said to comply with government regulations on censorship and could provide the company with a greater foothold in the world’s second-largest economy. The company has also opened a center for artificial intelligence research in Beijing, while Waymo has established a subsidiary as well as an office in Shanghai. Given that there are 1.3 billion potential consumers in China, an increasing exposure to the country could become a constant theme.
Product potential
The smart speaker market has proven to be a growth area for the business in the last quarter. Google Home’s smart speaker shipped 5.4 million of its devices to hold a 32.3% share of the worldwide market. With worldwide shipments of the devices having increased by 187% in the second quarter of the year, they are becoming increasingly popular. Although they provide modest levels of profitability in the short run, the valuable user data they collect can be used to send targeted ads to customers. Since advertising accounted for 87% of the company’s total sales in the 2017 fiscal year, the smart speaker market could be a catalyst on the group’s overall performance.
The company’s hardware division was a key driver in the 37% sales growth of its "Google other" segment in the most recent quarter. New product launches could keep this momentum going, with the company due to release Pixel 3 and Pixel 3 smartphones in the coming weeks. The Pixelbook 2 is also expected to be launched in the near term, while a Pixel Watch is set to serve as a showcase device for Wear OS. This could be the prelude to a fitness-oriented platform called Google Coach, which could help it to capitalize on growing demand for health-related technology.
Potential threat
With smartphone sales forecast to continue their recent decline, voice-activated search is expected to be a major growth market. Products such as Google Home and Amazon (AMZN, Financial) Echo have become increasingly popular, while smartphones themselves are increasingly being used by consumers to conduct voice-activated searches. It is estimated that by 2020, half of all searches will be voice searches, with 30% of all searches set to be undertaken without a screen. This means that Alphabet may find it increasingly challenging to show ads. Since it is reliant upon advertising for the vast majority of its revenue, the transition to voice-activated search could put pressure on its sales growth.
The extent to which voice search will replace keyboard-based search, though, may in itself be limited. A number of searches, such as when shopping or searching for a variety of news items, are still likely to require a screen. Evidence of this is the fact that only 2% of Amazon Alexa users have used the technology to shop, with only 10% of them becoming repeat buyers. Since the smartphone market is 21 times larger than the smart speaker market by volume, search-based ads may continue to dominate voice-activated search in future.
Outlook
Alphabet is continuing to evolve its business model. An increasing exposure to China and artificial intelligence are likely to be key growth drivers in the long run. New product launches and dominance in the smart speaker market may also help the company to overcome the risk of declining advertising revenue as voice-activated search becomes increasingly popular.
While the stock may have outperformed the S&P 500 in the last year, further capital growth could be ahead. An ability to adapt to a changing operating environment could lead to continued outperformance versus the S&P 500.
