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Alphabet (GOOG) Stock | NASDAQ: GOOG

Covered by Stratosphere

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Alphabet started with the Google search engine in 1995 and has since expanded into a digital advertising behemoth with colossal operations in daily productivity tools for individuals and businesses, YouTube and streaming, cloud, and plenty more.

Alphabet is one of the best businesses on Earth - it generates revenue every second of the day as businesses and individual consumers interact on Google products and services.

The strong core business in search and advertising enabled Alphabet to become a leader with AI, ML, data, and analytics. Not only does this benefit businesses looking to optimally advertise to make more money, but consumers benefit from content and products that meet their exact needs.

Alphabet's world-class development teams and swaths of data give the company an edge in innovation and optionality.

Stratosphere Score

10

Growth

7

Valuation

10

Quality

10

Margins

8

Dividend

0

Balance Sheet

10
Adrian Iwanicki

Author

Adrian Iwanicki

Equity Analyst

Investment Thesis

  1. Alphabet Inc. ("Alphabet") is a global technology behemoth that operates a myriad of interconnected businesses, including the Google search engine we all use daily. Alphabet makes most of its money from digital advertising on Google, but also operates YouTube and streaming, a suite of productivity tools for individuals and businesses, Google Cloud Platform, and futuristic ventures such as Waymo, an autonomous driving technology company.

  2. Businesses around the world leverage Google's large data pool and massive user base to effectively advertise their products and services to millions of eyeballs each day.

  3. Alphabet will inevitably benefit from the growth expected in digital advertising over traditional forms, growing YouTube content consumption resulting in improved YouTube direct response ad outcomes for businesses and rising YouTube TV and Premium subscriptions, underestimated value of the Google Cloud Platform, and asymmetric upside inherent in Alphabet's "other bets".

  4. Main risks to Alphabet shares and the business include regulatory scrutiny and antitrust investigations, Amazon's rapidly growing ad business, and the Google Cloud Platform falling behind Amazon's AWS and Microsoft's Azure.

  5. The core Google search segment may be one of the best businesses on earth spitting out an unreal amount of cash fueling investment in other areas of Alphabet. The core business still has a long runway for growth as digital advertising grows its total addressable market.

Key Company Metrics

A set of metrics we constantly keep updated to monitor the investment thesis.

Competitive Advantages

Global User Base

Alphabet's bread and butter, the Google Search engine, is arguably one of the best businesses on the planet. While users have plenty of search engines to choose from (Google, Bing, Yahoo, Ask, and more), people tend to flock to Google to ask questions, do research, search for images, and plenty more.

Search engines have extremely low switching costs from the perspective of a user. The user can switch from Google Search to Yahoo in the blink of an eye. Yet, Google effectively controls the global search engine market - it captured over 85% market share of search engines every period since 2010 and currently holds 87% of the market.

Alphabet has been able to amass a wide user base that behaves like there is no alternative. After all, this shows up in the numbers - Alphabet has a near monopoly on search engines. Maintaining a near monopoly in what appears to be a commoditized market from the outside does not "just happen". There are clear reasons behind Google Search's successes.

Data is a commodity. However, it is what you do with the data at hand that could be the difference between having a wide moat and a commodity product.

We believe Google Search is the greatest search engine to ever exist and will continue to host a user base that acts as if no alternative exists due to Alphabet's ability to provide the highest-quality and relevant search results.

If users get great search results on one engine quicker than any other platform, users will tend to come back to that engine. In fact, this is true with many products and services. The way Google Search is able to provide the best search results that helped dub the word "google" as a synonym for "search" is by constantly feeding its algorithms and leveraging artificial intelligence ("AI") and machine learning ("ML") to adapt to user behaviour on Google Search, locally curate results, and actively filter out "bad" search results.

Alphabet is well-known for its AI and ML capabilities, and it is the constant refinement and investment into these areas that unequivocally keep users close. Therefore, it is how Alphabet uses the data that flows through its assets that give it its greatest competitive advantage. Alphabet's competitors would have to sink large swaths of cash (that they likely do not have) into AI and ML systems that take years or even decades to develop (with development and engineering talent that does not match Alphabet's, and with far lower quantities of data). In simple terms, it is unlikely any competitor will ever catch up unless Alphabet stops trying.

With this, Google Search appeals to advertisers far more than other search engines. Not only do advertisers get millions of eyeballs viewing their ads, these advertisers are far more likely to maximize ROI (i.e., return on investment) from their ads on Google Search versus other search engines.

YouTube is a search engine too, and the results are similar. YouTube controls almost the entire video streaming market at 74% market share.

Inherent Network Effects

When we think of network effects, we usually think of areas that simultaneously benefit two separate parties on a platform or place. For example, messaging apps help people message each other, dating apps help people meet each other, and LinkedIn helps professionals meet with other professionals or job seekers meet employers (and vice versa). However, strong network effects are also created when there is data involved.

As previously mentioned, Alphabet's strong moat is due in large part to its strong AI and ML capabilities that advance as more people use Alphabet's platforms, especially Google Search, YouTube, and the Google Cloud Platform ("GCP").

Because of Alphabet's near monopoly in Search and video streaming (i.e., YouTube), and its strong position as a hyperscale cloud provider through GCP, users of most Alphabet services benefit from the usage of others. The act of others using Alphabet services quite literally makes them better for all of us.

The Alphabet Ecosystem

Alphabet serves a lot of our needs, and not just through Search and YouTube. Alphabet hosts a variety of internet / technology services that many use on a daily basis for personal tasks or for work.

Besides Google Search, GCP, and YouTube, commonly used products and services from Alphabet include Chrome, Google Drive, Google Docs, Android, Gmail, Google Maps, Google Photos, and Google Play, among others.

Each service contributes to the experience of using the Alphabet ecosystem and promotes usage of other Alphabet services given the seamless nature and high level of connectivity between them.

On a similar note, Alphabet is able to leverage its own ecosystem to drive many parts of its business. Most notably, Alphabet uses its infrastructure, security, data management, AI, and analytics capabilities to provide an array of cloud services. Google Cloud includes GCP and Google Workspace (formerly known as "G Suite") for the modern enterprise. Alphabet’s own products run on GCP and allow developers to build, host, and launch their own applications on the same infrastructure as some of the largest Alphabet products. Google Workspace provides Gmail, Docs, Drive, Calendar, Meet, and several other products - which are totally free to the individual user - for a fee to organizations requiring larger-scale collaboration tools.

Ultimately, the heavy usage of many of these free-to-use Alphabet products leads to a higher likelihood that Alphabet's money-generating properties will be used. For example, the prevalence of Gmail in our society makes Google Workspace a compelling option to equip an organization with organization and communication tools. Or, using Chrome, which is a high-performance web browser, certainly promotes the usage of Google Search, Alphabet's main cash-generating platform.

Some of these properties were internally generated, others were acquired (e.g. Android in 2005 and YouTube in 2006). In either case, building an ecosystem of any sort takes decades of work, heavy technological investments, high adoption rates, and a little bit of luck. Alphabet won in each of these fields and it now controls some of the most important "tools" in the world.

Opportunities Ahead

  • Digital advertising spend may ebb and flow as we exit the pandemic, but the secular trend is firmly in place. Digital ad spend will exceed 60% of total media ad spending for the first time in 2021 - 2022. Google has the most share in the global digital ad market, holding between 28 - 29% of the global market. Although Google is expected to lose modest share to Facebook, we believe Facebook holds assets with substantially more terminal risk than Google (i.e., Google will likely be around for longer than Facebook or Instagram). Nonetheless, Google is a behemoth in an oligopolistic global digital ad market that will continue to grow with this rapidly expanding industry.

  • YouTube continues to experience viewer growth and it is now, in fact, reaching more 18 to 49-year-olds than all linear TV networks combined. On top of this, advertiser effectiveness is increasing, watch time is increasing, and advertisers can reach young audiences that they cannot in other media.

  • Besides advertising, YouTube Premium and YouTube TV are gaining ground. The former has about 50 million subscribers and the latter has around 4 million subscribers. These non-ad revenue sources provide Alphabet with tons of vertical optionality as digital media usage increases and consumers shift away from linear TV sources.

  • Alphabet's GCP is the third-largest cloud provider, an underdog with a compelling value proposition. GCP’s main value proposition lies in what Alphabet already does best – artificial intelligence, machine learning, real-time data and analytics, and software development. GCP will continue to be unprofitable for the foreseeable future as it invests heavily into its product stack, data platform offerings, go-to-market strategy, and new regions. Alphabet provides these bundled cloud services for a reasonable price, a cherry on top for a service stemming from one of the world’s largest data collectors. These services should unlock tremendous amounts of opportunities through the 2020s – GCP will aid companies become more efficient and optimize costs as they move to the cloud, then help these businesses digitize their operations from head to toe.

  • Alphabet’s creators once said, "Google is not a conventional company. We do not intend to become one." Alphabet is not afraid to venture out into the unknown and pave its own path and we believe the "other bets" segment exemplifies the out-of-the-box thinking inherent in the company. Waymo is making promising moves in the self-driving vehicle realm, where its first fully autonomous ride-hailing service was launched in Phoenix, AZ. DeepMind is accelerating progress in biological research – its AI system, AlphaFold, was independently recognized in 2020 as a solution to the “protein folding problem”, which contributes to many diseases. Verily is also finding its way into our daily lives with its COVID-19 Testing Program expanding access to screening and testing and the COVID-19 Pathfinder automating frontline support for healthcare services. These bets are currently unprofitable, but we believe these ventures are future areas that could provide tremendous upside to society and Alphabet shareholders.

Risks

A company like Alphabet, despite its size and place in our lives, does not come without risks. We believe the following areas present the main risks to Alphabet’s business and share price today:

  • Regulatory scrutiny and antitrust investigations resulting in altered business practices and monetary fines for abuse of its power over markets, primarily in the ad space. Alphabet's massive market share, especially in search engines (Search and Youtube) are astronomically high and attract a lot of attention from regulators.

  • Margins may compress and stay lower than normal for extended periods as Alphabet remains in "investment mode". Heavy investments in all its businesses may make the business look less profitable than it is and eventually will be. However, we believe these investments are crucial for its future success.

  • GCP is behind Azure and AWS, despite its massive growth. Azure is growing rapidly off of a much larger base than GCP and remains attractive to cloud customers with the integration of Microsoft Office and other "essential" services.

  • Amazon is growing its ad business and proves it may be more than just a nuisance. Amazon advertising services are gaining market share and growing revenues quickly.

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