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Google (Alphabet): A free cash flow machine that is growing.

Opdateret: for 1 dag siden

Google (Alphabet) is the largest media company in the world and a well-known company. As we will see in this analysis, Google is a cash flow machine that continues to grow. Thus, there is no doubt that Google is a great company. However, there have been recent concerns about whether AI will disrupt Google's search business. Hence, the question is whether Google is still a great investment and if now is the right time to buy shares. It is what I will investigate in this analysis.

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, such as Microsoft. 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. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.

Google was founded in 1998 in California, United States. Google is an American multinational technology company specializing in internet-related services and products. These include online advertising technologies, a search engine, cloud computing, software, and hardware. Google has divided its business 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 88,7%. Google Services primarily generate revenue through advertising on Google Search and YouTube (approximately 87% of Google Services revenue). Additionally, they earn revenue through subscription services such as YouTube and Google One, Google Play from the sales of apps and in-app purchases, and the sales of devices. Google Cloud is Google's cloud business, which includes Google Cloud Platform and Google Workspace. It contributes to approximately 10,8% of the company's revenue. Other Bets consist 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 are what give Google its significant brand moat. and are, by far, the two most visited websites in the world. Besides that, Google has 91,62 % of the global search engine market share.

The CEO is Sundar Pichai. He first joined Google in 2004 and became the CEO 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 of Microsoft, and he has also been offered a top position at Twitter. When evaluating how employees rate him as a CEO, he ranks in the top 5% among companies with more than 10.000 employees. Historically, Sundar Pichai has done a great job at Google, as evidenced by the numbers that I share later in the analysis. Despite facing criticism for Google's delayed response to ChatGPT, I still believe he possesses the qualifications to lead Google in the future.

I believe that Google has a significant brand moat. I like the management as well. Now, let us investigate the numbers to determine if Google meets our criteria for a robust competitive advantage. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.

The first number we will look into is the return on invested capital, also known as ROIC. We require a 10-year history where all figures exceed 10% each year. Google has consistently achieved a solid return on invested capital (ROIC) over the past 10 years. They only had one year when they did not meet the requirement, but it is not a concern. Especially not because Google has managed to increase its Return on Invested Capital (ROIC) from 2018 onwards compared to the numbers before 2017. Google managed to achieve its highest Return on Invested Capital (ROIC) in 2021. Although there was a slight decrease in 2022, I am not concerned about it as that year was challenging for most companies. Despite this, Google managed to deliver a high Return on Invested Capital (ROIC). It is also encouraging to see that ROIC increased again in 2023.

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 actual numbers and the year-over-year percentage growth. Google is a textbook example of how you would like to see a company increase its equity. It has been growing steadily for the past 10 years, with an annual increase of over 10% in all years except for 2017, when it was very close to 10%. 2022 was a challenging year for most companies. Therefore, it is very encouraging to see Google's equity growing, even though it is at a lower percentage than what we are accustomed to. It is nice to see that Google is back to growing its equity by 10% a year again in 2023, which is impressive considering the size of Google.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow margin is used because I believe that margins provide a better understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Google consistently generates a significant amount of free cash flow year after year. There was a slight decrease from 2016 to 2018, but it is not a cause for concern. Especially not because Google has achieved a higher level of free cash flow since 2019 and beyond. 2022 was a challenging year for most companies, which is why I'm not concerned that free cash flow decreased slightly. Especially not when Google managed to generate a new record of free cash flow in 2023. Levered free cash flow margin is still high, even though it has not reached previous peaks. The free cash flow yield is higher than the ten-year average, which could indicate that Google shares are cheaper than usual. However, we will revisit this point later in the analysis.

Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. Upon calculating on Google, I found that Google has a debt of 0,16 times its annual earnings, which is excellent. 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 antitrust/anti-monopoly regulations. Google is frequently cited as a target for regulations in both the United States and Europe, with discussions taking place regularly. 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 observed in China will eventually be implemented in other markets as well. If he is correct, it will likely impact Google. Economic headwinds will reduce marketing budgets. Google generated more than 75% of its total revenues from online advertising in 2023. Expenditures by advertisers tend to correlate with overall economic conditions. Adverse macroeconomic conditions have affected, and may in the future affect, the demand for advertising, resulting in fluctuations in the amounts Google's advertisers spend on advertising. This situation could potentially harm Google's financial condition and operating results. Hence, if we experience a prolonged recession in the United States or Europe, it will affect Google's profitability. Competition. In its annual report, Google mentions that the business environment is rapidly evolving and intensely competitive. Google's businesses face changing technologies, shifting user needs, and frequent introductions of rival products and services. One of these new products is ChatGPT, and it is still uncertain how ChatGPT or other AI tools will affect Google's search business moving forward. Google is investing in AI and has mentioned that AI provides opportunities both on the organic side and on the monetization side. However, there is still uncertainty about how AI will disrupt Google's business.

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. To illustrate the immense potential of Google, let's take a look at the number of visitors these websites had in January 2024: had visitors, and had 108.661.719.317 visitors. The third most visited website was with 18.393.398.723 visitors. These numbers means that Google Search advertising revenues increased by 13% in 2023, while YouTube advertising revenue rose by 16% in the same year. Besides advertising revenue, Google is also increasing its subscription revenue, which reached $15 billion in 2023, indicating a fivefold increase since 2019. Subscription revenue is recurring and has high margins. Google also has a strong belief in YouTube Shorts and has mentioned that the monetization of YouTube Shorts continues to progress well. Google Cloud. Google Cloud became profitable in 2023 and continues to expand, achieving $33 billion in revenue in 2023, a 26% increase from 2022. It means that Google Cloud continues to be the fastest-growing cloud company globally. It means that Google is gradually catching up with its competitors, such as Microsoft and Amazon. Furthermore, the global cloud computing market is expected to grow at a CAGR of 16,4% until 2030. Currently, Google Cloud has an operating margin of 9%, which is significantly lower than the 30% operating margin for AWS. Thus, Google Cloud should also increase its margins, which will lead to higher profitability. Other Bets. It is a small part of Google, but it has potential. One interesting aspect is Waymo, which is the first company to operate fully autonomous ride-hailing services 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 compound annual growth rate (CAGR) of 49% until 2030, presenting another opportunity for Google.

Now it is time to calculate the price of shares in Google. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 5,80, which is from fiscal year 2023. I have selected a projected future EPS growth rate of 15% (Finbox expects EPS to grow by 16,4% per year over the next five years, but I am using 15% as the highest rate.) Additionally, I have chosen a projected future P/E ratio of 30, which is twice the growth rate. This decision is based on the fact that Google has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $174,00. 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 $87,00 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is called the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company is essentially its return on investment. The minimum annual return should be at least 10%. I calculate it as follows: The operating cash flow last year was 99.142, and the capital expenditures were 28.048. I attempted to analyze their annual report in order to determine the percentage of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 19.634 in our calculations. The tax provision was 11.922. We have 12.460 outstanding shares. Hence, the calculation will be as follows: (99.142 – 19.634 + 11.922) / 12.460 x 10 = $73.38 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Google's free cash flow per share at $5,55 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $87,61.

I believe that Google is a great company that still maintains a significant competitive advantage. I like the management despite the recent criticism. If you examine the numbers I have shared since Sundar Pichai assumed the role of CEO, it is clear that he has performed exceptionally well. Google is facing some risks. One of the challenges Google will continue to face is regulations stemming from the sector in which it operates and its size. However, I don't think that these regulations will alter Google's business. Macroeconomic factors may affect advertising spending, which in turn will impact Google's financials. However, macroeconomics will eventually improve after a downturn. Competition is the biggest risk for Google, in my opinion. The impact of AI on Google's search business remains unknown, and investors generally dislike uncertainty. It is something that will need to be monitored closely if investing in Google. However, there is no indication that AI will significantly disrupt Google's business in the short term. They still generate plenty of cash from their search business, and I don't see YouTube being disrupted by artificial intelligence at all. Google Cloud has the potential to grow, increase margins, and become a larger contributor to Google's free cash flow in the future. Through Other Bets, Google is exposed to some interesting sectors, but they are still speculative investments. It is uncertain whether any of these ventures will make a significant contribution to revenue in the future. While I have concerns about the uncertainty surrounding Google, I still recognize it as a free cash flow machine. I am inclined to purchase shares if they are priced around $100, which would provide me with a discount on the intrinsic value according to all three of my calculations.

My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how to do it, you can read this post.

I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.

Some of the greatest investors in the world believe in karma, and in order to receive, you will have to give (Warren Buffett and Mohnish Pabrai are great examples). If you appreciated my analysis and want to get some good karma, I would kindly ask you to donate a bit to the Donkey Sanctuary. You might not know it but the demand of traditional Chinese medicine could half the world's donkey population in the next few years. If you enjoyed this analysis and want some good karma, I hope that you will donate a little to the Donkey Sanctuary here. Even a little will do a huge difference to save these wonderful animals. Thank you.

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