Whenever you google something, watch a YouTube video or buy an Android smartphone, you kickstart the money-making mechanism of a company.
Let’s take a look at Alphabet Inc (GOOG ticker). This is a U.S. company with a capitalization of $915 billion and sales exceeding $155 billion. Its share in the S&P 500 index (ETFS PY) is as follows: Class C - 1.55%, and Class A - 1.54%. The issuer's total presence is 3.09%. Given these startling data, it’s hardly possible to ignore its market trend.
Alphabet Inc is based in California, USA. On February 1, 2016, it surpassed Apple in market capitalization. However, it seems that the holding had been looking for trouble with its monopolistic endeavors, and had been eventually fined €2.42 billion by the European Commission in 2017. On April 23, 2018, 118 out of the 1002 known IP addresses used by Google services were blocked by the Russian Federation.
In 2019, the holding acquired Fitbit, the smartwatch and fitness tracker maker, for €2.1 billion. Ironically, the number of fines is equal to the value of a whole company. However, such a huge turnover evidence the GOOG’s ability to generate significant cash flow.
What to know!
Initially, the company was called Google, and was founded by Larry Page and Sergey Brin.
The last name of the second founder clearly points to a non-American descent, and it’s very much so. Sergey Brin was born in Moscow in a family of mathematicians. They moved to the U.S. back in 1979. His father, Mikhail Brin, is a former research associate at the Research Institute for Economics under the State Planning Committee of the USSR, and a Candidate of Physics and Mathematics.
Mother is a former employee at the Institute for Oil and Gas, and later a climatologist at NASA. Even his grandfather, Israel Brin, is a Candidate of Physics and Mathematics and an associate professor at the Electromechanical Faculty of the Moscow Power Engineering Institute.
«I know about the challenges my parents had to face (when we lived in the Soviet Union), and I’ll be forever grateful to them for bringing me to the States».
This is how the best minds are leaving Russia. Had there been a different system, a political vector or better business conditions, perhaps U.S. wouldn’t be the place where the most famous search engine and a successful company were founded.
Larry Page, Ph.D. in Computer Science at the University of Michigan, met Sergey Brin at Stanford University. They registered their company in 1996, and in 1998 it started operating. Eric Schmidt, who worked at Xerox, Bell Laboratories and Zilog, was offered to take the position of the CEO in 2001.
Google manages more than a million servers, processes over billion searches queries and 24 petabytes of user data per day. If a person has a computer, an Android gadget, a Google account, or simply uses this search engine, almost everything about him or her becomes known.
So how does Google make $100 million per day? For starters, it’s the advertising. 94% of the holding’s income depends on the revenues from AdWords and AdSense even despite the decline in the average cost-per-click. This means that all key services, Google search engine, Android and Market Play, Maps and YouTube revolve around advertising. This is what company’s monetization looks like for advertisers.
And here is a selection of tools.Affiliate programs and the sale of in-house devices and solutions (Chromebooks, Chromecast digital media players, Google Cloud), as well as referrals for downloading Google Play apps generate extra income.
Google’s advantage is that the ads are linked to searches. That being said, there is no such targeted advertising like on Facebook, where the customer data collection is more extensive.
The company’s management has its eyes set on the future as well, investing in the development of AI and Waymo self-driving vehicles, GoogleFiber fiber broadband infrastructure.
One would think that the simple monetization idea has left for the U.S., but even the Russian Yandex is a company registered in the Netherlands. Unfortunately, the economy which bright minds are abandoning will remain second-rate and will only supply «raw materials» when the need arises, without being able to dictate its own terms. The pillars of the economic strength are precisely such mega-corporations which are capable of making billion-dollar contributions into the country’s welfare thanks to their turnover.
Since 2016, the increase in company's revenues has been more than +20% on average. The revenue had increased from $65.83 billion since 2014 and totaled $136.96 billion by the end of 2018. Net profit for the same time period went up from $13.62 billion to $30.74 billion. EBITDA increased from $21.3 billion to $40.57 billion, i.e. almost doubled over the course of four years.
Alphabet steps away from dividend policy, as if to say, we know better where to invest the cash we made; if you wish, you can buy stocks in hopes that the company continues to grow. EPS (earnings per share) indicator increased from an average of $22–30 to $40 per share by 2018. However, in order to make an analysis, we need to look into the latest quarterly reports.
We can see that the momentum has not been built yet, and Alphabet came to a halt at average values of around $12 per share for the quarter. In other words, the annual target for the foreseeable future is around $48 per share. This is better than in 2018; however, the growth isn’t so rapid.
If we buy it at the current price of $1345 per share, the PE rate at the expected EPS will be $28, which is far from the median value of 15. That means that in order to justify the current price, the holding needs a quarterly profit amounting to $22 per share. However, only $12.55 is expected in the January report so far.
Even if the company sticks to its four-year tradition, then at the current price, in order to justify the value, you would just have to wait and hope that there will be no market correction for another four years. Meanwhile, the fair price in terms of current reports is around $750.
It goes without saying that the market is capable of anything. That being said, as far as reasonable expectations and conservative approaches are concerned, it’s safe to say that ship has long sailed, and buying these shares would be like trying to catch up with it.
More often than not, it doesn’t do any good, especially in the case of deep market corrections. It will suffice to recall the recent story with Apple and its correction when expectations turned out to be inflated, and inertia continued until a couple of sobering reports came out, getting people back to reality. This is exactly when it becomes very uncomfortable to be at the top of the pyramid, but it’s too late.
Although I understand how one feels when you have analyzed the share or the market which had seemingly stopped growing, but then you are watching the continuing euphoria without having a position. That being said, it’s much safer that way than rolling down the pyramid.
It is hard to believe that such growth can stop, and the correction will reach $750. However, if you take a sober look at the reports and the price, and even set positive expectations that are realized in such a profitable business, the value of around $993 will seem more logical than a movement continuation on a retest from $1265.
In case of $993, it is enough for the issuer to reach a more realistic $16-17 EPS. The support is quite strong from a technical standpoint. However, in order to return below $1265 and initiate a complex false breakout, a solid market background and a deep correction of the S&P 500 are necessary.
Could this happen? Yes, it could, provided that the economic statistics that rolls out continues to have a bitter flavor. It is enough to take a look at the ISM of the production and non-production spheres, which in the short term may also affect the GDP figures. On the other hand, the «fuel» in the form of lowering of interest rates has a tendency to run out, and unpredictably lead to another issue - a spike in inflation.
So, I believe that in situations like that the most sensible way would be to adopt a wait-and-see approach than testing yourself by jumping without a parachute and without knowing the actual height you are doing it from.
Author: Viktor Makeeu