Pros and Cons of Buying Alphabet Inc (GOOGL, GOOG) Stock
There are only a handful of companies in the world that could argue they have power approaching Alphabet Inc (Nasdaq: GOOG, GOOGL). And ever since its initial public offering in 2004, GOOG stock has performed accordingly.
But the company behind the world's leading search engine is not the growth dynamo it used to be. On top of that, its rivals are getting stronger, and for the first time it's an open question in Silicon Valley whether Google might lose its search mojo sooner rather than later.
Here's a brief overview of the Mountain View, California-based technology giant, its core areas of business, and -- most importantly for prospective investors -- the pros and cons to buying GOOG stock.
Alphabet shares at a glance. In 2015, Google restructured its business and reincorporated itself as Alphabet, a holding company whose major subsidiary would be Google, the world's dominant search company. Under the restructuring, investors were able to differentiate the results between the cash-cow Google and its money-losing "moonshot" investments in the "Other Bets" category.
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Despite the separation, there's a reason the company kept its ticker as GOOG; Alphabet is still essentially just a big proxy for its crown jewel, Google.
The search giant controls more than 60 percent of the U.S. market, and likely 80 percent or more of the global market share.
GOOG stock's lifeblood is digital advertising, a massive and growing industry that, along with Facebook ( FB), it dominates. Google sells ads against its search results for specific terms, and also operates a sprawling ad network, placing ads on third-party sites for a cut of the resulting revenue.
With mobile overtaking desktop as the world's preferred search device, Google's Android operating system becomes ever more valuable; Android enjoys 80 to 90 percent market share and Google is the default search engine for Android.
YouTube, Gmail, Google Play, Pixel phones, Google Cloud and the company's expanding hardware business are a few of the big-name products and services aside from the search engine.
As for Other Bets, it accounts for only about 1 percent of Alphabet's overall revenue, and loses a disproportionate amount of money doing so. In Q4 of 2017, Google posted $8.76 billion in operating income while Other Bets posted an operating loss over $900 million. This is where some of the wacky and long-term projects live, such as Google Glass, self-driving cars, and anti-aging research.
Pros to buying GOOG stock. The first and most obvious advantage to owning Alphabet stock, is simply owning a piece of the biggest, baddest search engine in the world.
"Its core search and advertising model continues to dominate its markets and evolve as the advertising market shifts from online to mobile," says Kevin Walkush, portfolio manager for Jensen Investment Management.
To this point, total paid clicks in the fourth quarter of 2017 rose 43 percent year-over-year. And Android insures no other search company will meaningfully cannibalize its mobile share.
Robert Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pennsylvania, sums up the company's search dominance with a simple qualitative observation: "Google is being used as a verb to indicate when one is going to use a search engine," Johnson says. "This can be a tremendous advantage for companies selling a product or a service."
The second "pro" to owning GOOG stock, aside from its big-time search engine cash cow and exceptional brand, is the company's investment in diversification: self-driving cars, YouTube, artificial intelligence, cloud and voice search.
"Its YouTube video service is at the crux of the transition of video content from traditional media to online," Walkush says, as online video captures more and more of the traditional TV advertising budget.
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Longer term, several of those areas hold the type of game-changing potential that could launch a new era of growth for GOOG shareholders: In particular, AI and autonomous vehicles (AVs). Alphabet's Waymo subsidiary is already a leader in AVs, and Alphabet's R&D investments in artificial intelligence have made it one of the best AI companies too.
A line item dubbed "Google other revenues," which includes both Google Cloud and its Pixel mobile phones, grew revenue by 38 percent in the fourth quarter to $4.7 billion -- not bad for side businesses.
And finally, chief financial officer Ruth Porat has brought more fiscal responsibility to the company. "Alphabet hired Ruth Porat as CFO in the spring of 2015, and we view her hire as a big step toward 'grown up' management," Walkush says.
Cons to buying GOOG stock. Interestingly enough, one of the biggest cons to buying Alphabet shares is the fact that Amazon.com ( AMZN) exists. Not only that it exists, but that it's attacking the search giant on all fronts.
Perhaps the greatest long-term risk Amazon poses to GOOG is its encroachment into voice search -- perhaps the future of search itself -- where its Alexa virtual assistant has a huge first-mover advantage.
Amazon is also seizing digital advertising dollars, as marketers shift spending to Amazon.com's growing platform and more and more lucrative product searches begin on Amazon than Google. In cloud, Amazon Web Services is the clear market leader, with Google Cloud playing catch-up, and Jeff Bezos's ruthlessly opportunistic company is also devoting time, energy and resources to AI.
Another thing to worry about is the specter of regulation, which is getting bigger and bigger headlines.
"Facebook's problems have already attracted scrutiny that could envelop all of the major internet services giants," says Barry Randall, chief investment officer of Crabtree Asset Management. "When politicians start using the phrase 'too much power' about companies, the regulatory climate rarely improves from that point forward."
Lastly, GOOG stock is arguably somewhat overvalued. By no means is Alphabet the most egregiously priced company in the market, or even the most overpriced in Silicon Valley -- but there seems to be a moderate cyclical overvaluation, and GOOG shares are affected by this.
Alphabet trades for about 34 times adjusted earnings, and yet earnings per share grew at just 15 percent in 2017. Legendary growth investor Peter Lynch advised trying to buy stocks at a price-earnings ratio equal to or less than the earnings growth rate, and that rule of thumb still stands today.
Bottom line for GOOG stock. No stock is perfect, and Alphabet is no different. But the company does have an incredible competitive advantage in search, and works hard to innovate and stay on top of its cash cow, while diversifying its business and researching areas for future dynamic growth.
[See: 8 Catalysts That Are Moving Amazon Stock.]
There's no other company in the world positioned the way the Alphabet is, and that's the most compelling fundamental reason to buy. Still, GOOG stock is arguably expensive, and buying it at an elevated price means you may have to wait a bit longer for great returns.
If you're holding for the long-term though, and want to own one of the most compelling companies in tech, there's nothing wrong with buying some GOOG now and adding more if and when it pulls back.
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