How To Play GOOGL Stock Going Into 2017

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Alphabet's (NSDQ:GOOGL) stock price has been nearly flat in the last twelve months despite the company posting average YoY revenue growth of 19.65% in the last three quarters. The double digit growth rate is staggering because Alphabet’s quarterly revenues are already well over $20 billion. What’s even more surprising though, is the meek response from the market, which decided to completely overlook the strong growth numbers. Now with Facebook (NSDQ:FB) doing a stellar job both financially, and in terms of stock performance, comparisons are being drawn again. Can Facebook really dent Alphabet Inc?

 A Valuation Problem?

One of the major factors that resulted in the market’s muted reaction is Alphabet’s current valuation. The stock is already trading above 6 times sales and 28 times earnings, which is a bit on the high side for a technology company of Alphabet’s size and scale. A lot of that double-digit growth seems to have been already priced in and, as a result, the stock kept moving sideways.

The other factor that is also playing an important role is the growth expectation. The online advertising industry still has plenty of room to grow, but a large portion of that growth will come from developing markets that are comparatively less profitable than developed markets, and also due to the shift from desktop to mobile.

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The impact of that shift can already be seen in the way Alphabet’s aggregate cost per click has declined in the last two years. At the same time, the total number of clicks has increased. The shift to mobile as well as the increasing traffic from new markets are jointly giving more click volume, but lower revenue per click. This trend will continue, it is not something that Alphabet can snap itself out of that easily; and in all likelihood we might see this accelerate in the next few years as mobile usage in developing markets increases. 

Margins Gaining Stability, and No Competitor Breathing Down its Neck

Google’s operating margin has been coming down as result of these changes but, thankfully, the numbers are a tad more stable this year. The decline in operating margins was not because Alphabet had to cut down its pricing because of competition, but more because of the shift in market dynamics we discussed above.

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Despite the decline, however, Alphabet’s advertising machine remains a cash cow for the company and will remain that way for many more years to come, as there is no clear rival that can give an advertiser more leverage for its ad dollars.

Facebook (NSDQ:FB) might have overtaken Alphabet in the news traffic referral race, but the company is still many years away from the market leader in terms of revenues. Traffic referral is basically the volume of web visits that go to a website after users have clicked a link. With Google, it’s about clicks on search results, news links and so on; with Facebook, it’s about clicks to advertised or organic linked posts.

The Facebook threat is certainly there for Alphabet, but there’s plenty of time before the social media giant can mount a full-scale attack on Google revenue streams. Again, with the shift to mobile, Facebook benefits from increased traffic and ad revenues, but it’s far behind in the video space, which YouTube will continue to dominate for the foreseeable future.

“YouTube revenue continues to grow at a very significant rate, driven primarily by video advertising across TrueView, with a growing contribution from buying on DoubleClick Bid Manager.” - Sundar Pichai, CEO, Google

Table for Two, Please!

That balance will keep Facebook at bay for now, but there’s also another factor to consider. The online advertising market might be growing at a rapid pace, but has yet to ‘come of age’, as it were. Print advertising may have taken a hit in the last five years, but television still holds the lion’s share of ad revenues globally.

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Source: Intelliassist

That means the growth opportunity isn’t only there for newer players like Facebook; it is very much there for Alphabet as well, as they’ve shown over recent quarters.

Therefore, it stands to reason that even if Facebook is able to show rapid growth - and they’ve already warned of reaching optimal ad loads - over the next few quarters, all Alphabet needs to do is keep their own double digit growth intact for them to fend off Facebook.

In Summary

Put all these factors together and it’s clear that the runway is long for Alphabet’s Google. Notwithstanding the fact that Other Bets have largely shown disappointing results until now, the ad engine is sufficiently primed to sustain whatever growth levels Google is experiencing at this point.

For an investor, the only cause for worry will be the valuation of 6+ times sales. Your returns may take a while to come, so do give yourself some margin for error. The best way is to build your position over a period of time, especially during dips. That way, you get to keep your cost basis down as much as possible, yet accrue value to your portfolio over time.