Google (Alphabet): A free cash flow machine that is growing.
Opdateret: 10. jul.
Google (Alphabet) is the largest media company in world and a company that everyone knows. As we will see in this analysis, Google is a cash flow machine with a large moat. Thus, there are no doubt that Google is a great company, the question is, if now is 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 shares in Google (Alphabet). I do own shares in some of their competitors in Meta (advertising) and Microsoft (cloud). If you would like to copy or see my portfolio, you can do so here. However, once I have finished building my position in Alibaba (9988 in Hong Kong), I consider using the weekly extra income to dollar cost averaging into Google. I believe that everyone can and should get an extra income used for investing. My suggestion to get an extra income every week can be found here. Finally, I should mention that I know that the company name is Alphabet, but I will call it Google throughout the analysis.
It is hard to briefly explain what Google does. I believe everyone knows Google; hence I don't want to go into too many details about what they do. Instead, I will use the definition from Wikipedia that defines Google to be an American multinational technology company that specializes in internet-related services and products, which include online advertising technologies, a search engine, cloud computing, software, and hardware. Google themselves has divided their business in three different segments: Google Services, Google Cloud, and Other Bets. Google Services is ads, Android, Chrome, hardware, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Search and YouTube. Google Services contributes to most of the revenue with around 90 %. Google Cloud is their cloud business including Google Cloud Platform and Google Workspace and contributes to around 7 % of the revenue. Other Bets consists of businesses such as Waymo their autonomous drivng, Wing their drone delivery, X their software for industrial robots and many other things. Google Services is what gives Google their huge brand moat. Google.com and YouTube.com are by far the two most visited websites in the world. Besides that, Google has 92,49 % of the global search engine market share.
Their CEO is Sundar Pichai. He first joined Google in 2004 and became the CEO in Google in 2015 and the CEO of Alphabet (The holding company for the Google company family) in 2019. He has a degree in metallurgical engineering from India, a Master of Science in materials science and engineering from Stanford University and an MBA from Wharton School of the University of Pennsylvania. He started as a product manager, where he oversaw products such as Google Chrome, Google Drive and later Gmail and Google Maps. As a product manager he was known for recruiting, mentoring, and retaining a great team, while being great at navigating in politics, which meant he was very well respected. He is also known for being strongly opinionated, while still letting people's opinion emerge before he gives his own. It is not only Google that appreciated Sundar Pichai, as he was also rumored to become the CEO in Microsoft, while he has also been offered a top job at Twitter. When looking on how employees score him as a CEO, he is in the top 5% of companies with more than 10.000 employees. Needless to say that his results show that he indeed has the credentials to lead Google to success.
I believe that Google has a huge brand moat. I really like the management as well. 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 investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years. Google has delivered a solid ROIC over the last 10 years. They only had one year where they didn't meet the requirement, but it isn't any concern. Especially not because Google has managed to increase their ROIC from 2018 and onwards compared to the numbers before 2017. It will be interesting to see if 2021 is an outlier or if Google manages to take their ROIC to this level moving forward. All in all, I'm very encouraged when I see a ROIC like this.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Google is a textbook example of how you would like to see a company growing their equity. It is growing year over year for the last 10 years, and by more than 10 % in all years except one, which was as close to 10 % as you could be. I'm really encouraged when I see numbers like these.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Google is delivering a lot of free cash flow year over year. There was a slight decrease from 2016 to 2018 but it is not anything to worry about. Especially not because Google has delivered free cash flow at another level than previously from 2019 and onwards. As I wrote in the headline, Google is a free cash flow machine.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 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 017 years earnings in debt, 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 obvious that Google is a great company. However, no investments are without risk and Google do have a few risks as well. One risk is anti-trust / anti-monopoly regulations. Due to the size of Google and their huge market share, they 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 hard to predict if it will amount to something for Google, but it is something that is worth monitoring. Interestingly, Martin Lau, the President of Tencent, has previously stated that the internet regulations we have seen in China, will be something we will see in other markets as well eventually. Economic headwinds will cut marketing budgets. Google makes most of their revenue from advertising, and the latest "International Business Barometer" report from Sapio Research suggests that half of all businesses anticipates cutting discretionary marketing spend over the next 12 months. At present, just 6 % of companies are cutting marketing budgets. If the report is right, it means that Google will face some challenges in the next 12 months. Competition. Google is a great company with a huge moat, which should protect them from most competition. However, they are competing with other great companies such as Meta in advertising, and Amazon, Microsoft, and Alibaba in cloud services. I believe that competition will always be a risk when competing with companies such as these. And so goes Google as they mentioned competition as one of the largest risk factors in their latest annual report.
There is also great potential for Google moving forward. If we look at the different 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 for Google, I want to share just how many visited the websites in May 2022: google.com had 220.127.116.114 visitors and youtube.com had 27.574.882.220 visitors. The third most visited website was facebook.com with 9.994.055.440 visitors. I think that Googles services will do just fine moving forward. But don't take my words for it, according to Manga Global's June forecast, they believe that US search advertising spend will grow from 17,4 % to 17,6 %, while social media advertisement spend growth will drop from 15,7 % to 10,5 %, It suggests that Google should perform better than companies that focuses on social media advertisement. Furthermore, the global advertisement market is expected to grow by an 8,6 % CAGR until 2028. It means that there are still plenty of growth ahead for Google's core business despite economic headwinds. Besides that, there are all the other things in the segment that could grow as well. Google Cloud. Google Cloud isn't profitable yet, but it is growing at a great pace. In the first quarter in 2022, revenue grew by 44 % year over year. According to Bloomberg, Google Cloud is growing at a faster pace than their competitors. From 2017 to 2021 Google Cloud grew at a 36 % CAGR, while Microsoft Azure grew by a 32 % CAGR and Amazon AWS grew by a 29 % CAGR. It means that Google is slowly catching up with their competitors Furthermore, the global cloud computing market is expected to grow by a 16,3 % CAGR until 2026. If Google manages to make their cloud business profitable, it could be another growth catalyst. Other Bets. It is a small part of Google, but it has potential. One interesting part is Waymo, which is the first company to fun fully autonomous ride-hailing operations in multiple locations simultaneously. With the self-driving vehicle market forecasted to be worth $2,1 trillion by 2030, this has enormous potential. Wings completed over 50.000 commercial deliveries in the first quarter in 2022, which is up more than 3x year-over-year. The drone package delivery market is expected to grow by a 49 % CAGR until 2030, which makes is another huge 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 80, which is lower than the one in 2021 of 112,2 but higher than the one in 2020 of 59,42. I chose an Estimated future EPS growth rate of 15 (which is the highest possible growth rate I use), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Google has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $2.400, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Google at price of $1.200 (or lower obviously), if we use the Margin of Safety price. (1.200 / 20 = $60 after the stock split)
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 91.652. The Capital Expenditures was 24.640. I tried to look through their annual report to see, how much of the capital expenditures were used on 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 expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 17.248 in our further calculations. The Tax Provision was 14.701. We have 667,65 outstanding shares. Hence, the calculation will be like this: (91.652 - 17.248 + 14.701) / 667,65 x 10 = $1.335 in TEN CAP price. (1335 / 20 = $66,75 after the stock split)
The last calculation is the PAYBACK time. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 77,6 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $1.907. (1.907 / 20 = $95,35 after the stock split)
I believe that Google is a great company with a huge moat. I really like the management as well. I'm not too worried about Google when it comes to economic headwinds or even recession. I believe that Google will still fair relatively well in those conditions due to their huge market shares. 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 Kahn 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 try to predict on how it will affect the business of Google. It is just a risk that needs to be monitored. I would like to see Google being able to make their cloud business profitable over time and while their other bets could be something that will generate profit in the future there are still a lot of uncertainty. However, I absolutely love their advertisement business and it is enough for me to invest in the company. If Google reaches $1.907 / $95,35, I will not hesitate to open a position. I might even open 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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