Image Source: Pixabay

Whenever a company that makes products or services that billions of people use daily pops up in the Green Screens, I perk up.

So you can imagine the degree of perkiness when a company that can boast of no fewer than 9 products with 1 billion daily users found its way into the screens recently!

Yes, as many of you probably guessed, that company is Alphabet (GOOG), known more commonly as Google (which I’m going to refer to it as through this write-up).

It would be an absolute crime not to take a deeper look at such an important company, one that is still meeting the growth and cash generation targets demanded by our screens. So let’s dive in and see if Google meets all of our criteria to be a "Green Dot" stock, and if so, what a good buy-in price is for investment.

How Google Makes Money

This is a large, sprawling company with a big product portfolio, but it basically boils down to 3 business units.

Google Services

Google Services is what most people associate with the company, and indeed this segment generates 88% of all revenues and over 95% of operating profits with a 35% operating margin.

All of those aforementioned 9 products with 1 billion daily users fall under this segment: Search, Android, Chrome, Gmail, Drive, Maps, Google Play, YouTube, and Google Photos. This segment also includes Google Network, which allows small publishers to serve ads from Google on their websites, making some money off their traffic.

The vast majority of revenue from this business unit (over 85%) comes from cost-per-click or cost-per-thousand-impression fees to serve ads through text, videos, and images on the various Google properties (primarily text-based search ads and video ads on YouTube).

The remainder of revenues in this segment come from sources like consumer subscriptions to YouTube services, platform sales such as Google Play app and in-app purchases, and device sales for the Pixel family of consumer electronics devices.

Google Cloud

This business unit includes the Google Cloud Platform (GCP) and Google Workspace offerings. These provide a comprehensive suite of infrastructure, platform, collaboration, security, storage, and A.I. tools for businesses to use in establishing a cloud-based digital presence. GCP provides the online underpinnings for some very big brands, including Unilever, LG Electronics, Major League Baseball, and many more.

Revenues for Cloud come from consumption-based fees (bandwidth and storage), as well as recurring subscriptions. Cloud segment accounted for 11% of company revenue in 2023, with a 9.4% operating margin.

Other Bets

"Other Bets" is a rollup that includes all of the company’s investments in various moon-shot opportunities. It is not material to the firm’s results (less than 1% of revenue), although it has consistently generated large operating losses (over $850 million in 2023, which was a big improvement from prior years). The most notable "Other Bets" units are Waymo, focused on self-driving cars, Verily, a life sciences firm that has delivered some successes with glucose monitoring, and Nest, which produces "smart home" devices like thermostats and smoke alarms.

The Growth and Recurring Revenue Story

Let’s start with the ads business, which is 2/3rds of sales. Generally, I consider large advertising platforms to be recurring revenue of the "toll booth" variety, as a little cut is taken for every ad served on the various platforms. It is important to remember that ad volume will ebb and flow with economic conditions, but it is not generally at risk to dramatically decline or go away in very short periods of time.

The remainder of Google’s revenue is from subscriptions or usage-based fees. Both of these are clearly recurring models. So, by and large, the firm’s revenue comes from solid recurring sources.

Now, on to growth.

At a market cap of nearly $2 trillion (the 3rd largest U.S. company by market cap), and 2023 revenues of over $300 billion, investors should not expect explosive, 20%+ growth out of Google. Its 3-year compound annual growth rate is impressive at 19%, but forward targets are more in the 9-12% range. Those are much more achievable.

Google operates in simply immense markets. Digital advertising worldwide was a $600 billion industry in 2022, growing at about 4-7% annually to reach over $800 billion by 2028. The mobile apps market is worth over $200 billion. Streaming video will be worth $400 billion by 2028 (growing at over 20% annually). Cloud computing platform spend came in at over $600 billion in 2022 and is growing at 15% annually, reaching an amazing $1.2 trillion by 2028.

Put all those together and you get an unfathomable $2.7 trillion in addressable market by the end of the decade. That leaves plenty of room for even a firm as large as Google to generate solid revenue growth numbers for the foreseeable future.

How Wide Is The Moat?

Famed (and recently deceased) investor Charlie Munger, Warren Buffett’s confidant for decades, once said Google had the widest moat he had ever seen. The two publicly lamented never buying Google for Berkshire Hathaway’s investment portfolio.

Let us count the ways Google’s moat is one of the widest in the business world.

First, there is the BRAND. You don’t do an Internet search for something - you "Google it"! Simple tip - anytime a company’s name becomes a common verb or noun, chances are you’ve got a powerful brand moat going on. The firm maintains a 91.5% share worldwide in internet search, despite tremendous competition for decades from well-financed adversaries. This dominance has helped it establish leading positions in many key internet-based spaces, including web browsers (Chrome has 66% usage share), online mapping (67% share), and consumer email (Gmail has a leading 43% share).

The brand moat doesn’t just stop at "Google". YouTube remains the #1 video-based social media network on the planet, with 2.7 billion monthly users (double the size of TikTok). Consumer trust in the Google platform helped Android to grow to 70% of the worldwide mobile phone market, and Google Play is by far the most popular App Store in the world, with twice as many downloads as Apple’s.

There are also NETWORK EFFECTS at play. Search has the biggest one - advertisers virtually HAVE to spend with Google to utilize their incredible 8.5 billion daily searches. Consumers use Google Search because it gives (by far) the best results. The same applies with YouTube - consumers flock there because it has the most content, which means advertisers can reach the most eyeballs. Android and Google Play can boast similar network dynamics when it comes to applications.

Lastly, there are clear SWITCHING COSTS in some of Google’s product portfolio. Cloud infrastructure is highly disruptive to migrate, once established. Most consumers stay with one mobile operating ecosystem from phone-to-phone in order to maintain their apps and data. While switching costs are not the strongest of Google’s moats, they certainly contribute to it.

With 3 powerful moats, I think Charlie was clearly on to something. Despite a lot of competition, Google has tremendous competitive advantages that should protect its business for decades.

Management and Finances

Google is led by Sundar Pichai, who took over in 2019. He has been with the company since 2004, and was CEO of the Google "business unit" since 2015. Effectively, he has more or less been running the company for almost a decade now, during which it has increased revenues and free cash flow at a 20% annual clip.

Ruth Porat is another important figure in the company. She joined in 2015 after a stint as CFO at Morgan Stanley, and is one of the more highly regarded chief financial officers in the business world. Currently she is transitioning to be more of a president / chief investment officer for the company, but still holds the CFO title until a replacement is found.

Finally, co-founders Larry Page and Sergey Brin remain as board members. They have majority voting power (53%) through 88% ownership of Class B shares.

Financially, the company is a rock. It carries nearly $150 billion in cash and investments vs. just $13 billion in debt. Free cash flows have been remarkably steady at 28-30% of revenues for at least the last decade. Cash returns on capital are phenomenal for a company of this size (45%!).

No complaints on any level here.

Risks

This is without question one of the "lower" risk stocks we’ve reviewed. Google is so large, so well known, and so absolutely integral to people’s day-to-day lives that it would take some very serious events to materially damage its business.

Clearly the biggest risk is the reliance on ad revenues. Ad spend is very economically sensitive. In the past the measurable nature of digital advertising (vs. traditional print/TV ads) cushioned the impact for Google, but the company is not immune. At its current size, it wouldn’t surprise me to see revenue slow or even turn slightly negative during the next recession.

Google’s end markets remain highly competitive. Some of the world’s largest companies compete in digital advertising (Facebook/Meta), mobile platforms and devices (Apple), cloud services (Amazon and Microsoft), and streaming video (pretty much everyone). A.I., a traditional strength for Google, is now being pursued by everyone. The company will have to continue to spend and innovate to keep up.

Lastly, Google faces a lot of regulatory scrutiny given its dominance in numerous lucrative consumer markets. Laws have already been passed limiting the kind of tracking data Google uses to service its ad customers, and it was recently fined 2.6 billion euros by the EU for anti-trust violations. There will always be a target on its back from both governments and competitors.

Conclusion

It should come as little surprise that Alphabet easily passes all the tests for a "green dot" stock. It has a strong set of "toll booth" and "subscription" recurring revenue models. Despite its size, the company is selling into truly enormous markets worth almost 9 times its current revenue. It has 3 tremendous economic moat advantages. It is led by a proven management team and has financial metrics most firms can only dream of. Simply put - it is a no-brainer for addition to the Watch List.

That decided, let’s figure out a fair price for the stock. Google’s revenue has slowed considerably over the past 2 years, so I think a modest 10% growth number is fair for the next 5 years. On the other hand, the company is a strong share repurchaser, so a 2.2% annual share decline is a fair expectation. Combined with a predictable 28% free cash flow margin, and a standard 10.5% discount rate, I see the stock worth about $118 per share.

At a current $144, the stock looks a bit rich at the moment. We will keep an eye out for a good buy-in price over the next several months (or years).

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