Google (Alphabet): A free cash flow machine that is growing.
Opdateret: 7. aug.
Google (Alphabet) is the largest media company in the world and a company that everyone knows. As we will see in this analysis, Google is a cash flow machine with a significant competitive advantage. Thus, there is no doubt that Google is a great company. The question is, is now the time to buy the stocks?
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in Google (Alphabet). I do own shares in some of their competitors in Meta (advertising) and Microsoft (cloud). If you would like to view or copy my portfolio, you can do so here. Despite owning shares in some of their competitors, I will ensure that the analysis remains unbiased. If you want to purchase shares or fractional shares of Google, you can do so through eToro.
It is difficult to provide a concise explanation of what Google does. I believe everyone knows Google; therefore, I don't want to go into too many details about what they do. Instead, I will use the definition from Wikipedia, which defines Google as an American multinational technology company specializing in internet-related services and products. Theseinclude online advertising technologies, a search engine, cloud computing, software, and hardware. Google has divided itsbusiness into three different segments: Google Services, Google Cloud, and Other Bets. Google Services include ads, Android, Chrome, hardware, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Search, and YouTube.Google Services contribute to the majority of the revenue, accounting for approximately 89%. Google Cloud is Google'scloud business, which includes Google Cloud Platform and Google Workspace. It contributes to approximately 10% of the company's revenue. Other Bets consists of businesses such as Waymo, which focuses on autonomous driving; Wing, which specializes in drone delivery; and X, which develops software for industrial robots, among other ventures. Google Services is what gives Google its huge brand moat. Google.com and YouTube.com are, by far, the two most visited websites in the world. Besides that, Google has 93,37 % of the global search engine market share.
Their CEO is Sundar Pichai. He first joined Google in 2004 and became the CEO of Google in 2015. In 2019, he also became the CEO of Alphabet, the holding company for the Google company family. He holds a degree in metallurgical engineering from India, a Master of Science in materials science and engineering from Stanford University, and an MBA from the Wharton School of the University of Pennsylvania. He started as a product manager, overseeing products such as Google Chrome, Google Drive, and later Gmail and Google Maps. As a product manager, he was known for his ability to recruit, mentor, and retain a highly skilled team. He was also adept at navigating office politics, which earned him a great deal of respect. He is also known for being strongly opinionated, while still allowing people's opinions to emerge before he gives his own. It is not only Google that appreciated Sundar Pichai; he was also rumored to become the CEO ofMicrosoft, and he has also been offered a top job at Twitter. When evaluating how employees rate him as a CEO, he ranksin the top 5% among companies with more than 10.000 employees. Needless to say, his results show that he indeed has the credentials to lead Google to success.
I believe that Google has a significant brand moat. I really like the management too. Now let us investigate the numbers to see if Google lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will look into is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all the numbers being above 10% in each year. Google has consistently achieved a solid Return on Invested Capital (ROIC) over the past 10 years. They only had one year where they didn't meet the requirement, but it isn't aconcern. Especially not because Google has managed to increase its ROIC from 2018 onwards compared to the numbers before 2017. Google managed to achieve their highest Return on Invested Capital (ROIC) in 2021. Although it experienced a slight decrease in 2022, I am not concerned about it. 2022 was a challenging year for most companies, and yet Google managed to deliver its second highest ROIC to date.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. Google is a textbook example of how you would like to see a company grow its equity. It is growing consistently for the past 10 years, with an annual increase of more than 10% in all years except one, where it was very close to 10%. 2022 was a challenging year for most companies, so it is very encouraging to see Google's equity growing, even though it is at a lower percentage than what we are accustomed to.
Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after it has covered its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Google is generating a significant amount of free cash flow consistently year after year. There was a slight decrease from 2016 to 2018, but it is not anything to worry about. Especially not because Google has achieved a higher level of free cash flow since 2019 and beyond. As I mentioned in the headline, Google is a cash flow machine that generates free cash flow.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do so by dividing the total long-term debt by earnings.Doing the calculation on Google, I can see that Google has a debt of 0,17 years' earnings, which is great. Hence, the low debt is another reason to be excited about Google as an investment.
Based on my findings so far, it is evident that Google is an exceptional company. However, no investments are without risk, and Google does have a few risks as well. One risk is antitrust/anti-monopoly regulations. Due to Google's size and significant market share, it will always be a target for anti-trust/anti-monopoly regulations. I don't think a month goes by without Google being mentioned as a target for regulations in either the United States or Europe. It is difficult to predict if it will amount to something for Google, but it is worth monitoring. Interestingly, Martin Lau, the President of Tencent, has previously stated that the internet regulations we have seen in China will eventually be implemented in other markets as well. Economic headwinds will reduce marketing budgets. Google makes most of its revenue from advertising. According to a survey conducted by the World Federation of Advertisers, nearly 30% of the 43 multinational companies included in the survey plan to reduce their advertising budgets in 2023. If the survey is correct, it indicates that Google will encountersome challenges in the next 12 months. Competition. Google is a great company with a significant competitive advantage, which should protect them from most competition. However, they are competing with other great companies such as Meta in advertising, and with Amazon, Microsoft, and Alibaba in cloud services. Furthermore, we don't know how ChatGPT will impact Google's business. I believe that competition will always be a risk when competing with companies like these. This is evident in Google's latest annual report, where they mentioned competition as one of the largest risk factors.
There is also great potential for Google moving forward. If we examine the various segments of Google. Google Services. Google has the two most visited websites in the world, and to give you an idea of the enormous potential of Google, I want to share just how many visitors the websites had in June 2023: Google.com had 93.445.715.962 visitors and Youtube.com had 82.814.224.747 visitors. The third most visited website was Facebook.com with 11.420.696.832 visitors. I think that Google’s services will do just fine moving forward. But don’t just take my word for it. According to Statista, search advertising spend is projected to grow at a CAGR of 8,69% until 2027. It means that there is still plenty of growth ahead for Google’s core business despite economic headwinds. Besides that, there are also other things in the segment that could grow as well. Google Cloud. Google Cloud isn't profitable yet, but it is growing at a rapid pace. From 2021 to 2022, Google Cloud revenue grew by 32%. Google Cloud is also growing faster than both Amazon's AWS and Microsoft's Azure in each quarter of 2022. It means that Google is gradually catching up with its competitors. Furthermore, the global cloud computing market is expected to grow at a CAGR of 16,3% until 2026. If Google manages to make its cloud business profitable, it could serve as another catalyst for growth. Other Bets. It is a small part of Google, but it has potential. One interesting aspect is Waymo, which is the first company to run fully autonomous ride-hailing operations in multiple locations simultaneously. With the self-driving vehicle market forecasted to be worth $2,1 trillion by 2030, it has enormous potential. Google's drone delivery company, Wing, is expected to deliver millions of packages by mid-2024. The drone package delivery market is expected to grow at a CAGR of 49% until 2030, which makes it another opportunity for Google.
All right, we have gone through the numbers, potential and risk regarding Google, and now it is time for us to calculate a price for Google. To calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use the EPS of 5,61, which is from 2022. I chose an estimated future EPS growth rate of 13% (Finbox expects EPS to grow at 13,4% in the next five years). I also selected an estimated future PE of 26, which is double the growth rate, as the historical PE for Google has been higher. Additionally, we have already established a minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $117,15. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Google at a price of $58,58 (or lower, obviously) if we use the Margin of Safety price.
Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 95.001. The capital expenditures were 29.816. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn't find it though, as the annual report just concludes that "capital expenditures primarily included investments in technical infrastructure". Hence, as a rule of thumb, you can expect 70% of the capital expenditures to be allocated for maintenance. This means that we will use 20.871 for our further calculations. The tax provision was 13.398. We have 13.078 outstanding shares. Hence, thecalculation will be as follows: (95.001 - 20.871 + 13.398) / 13.078 x 10 = $66,93 in Ten Cap price.
The last calculation is the Payback Time. I also described in "MY STRATEGY". With Google's Free Cash Flow Per Share at 4,64 and a growth rate of 13%, if you want to recoup your purchase in 8 years, the Payback Time price is $66,89.
I believe that Google is a great company with a significant competitive advantage. I really like the management too. I'm not too worried about Google when it comes to economic headwinds or even a recession. I believe that Google will still do relatively well in those conditions due to their huge market share. Anti-trust and anti-monopoly regulations are something I'm more worried about. I believe that we will see regulations in Europe and especially in the United States, as Lina Khan has been appointed as Chairperson of the Federal Trade Commission. However, I don't think the regulations will be as severe as in China, and I don't want to speculate on how they will affect Google's business. It is just a risk that needs to be monitored. I would like to see Google become profitable in their cloud business over time. While their other bets may have the potential to generate profit in the future, there is still a lot of uncertainty. We also have uncertaintyabout ChatGPT, which could affect Google's business moving forward, but we still don't know. Nonetheless, I absolutelylove their advertising business, and it is compelling enough for me to invest in the company. If Google reaches the TenCap price $66,93, I will not hesitate to open a position. I may even consider opening a position at a higher price, as I don't necessarily need a 50% discount when investing in a company like Google.
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